Incidence of Capital Income Taxation in a Lifecycle Economy with Firm Heterogeneity

Abstract

We study the incidence of capital income taxation in a dynamic general equilibrium model with heterogeneous rms and lifecycle households. In this incomplete market setting, marginal excess burdens of three capital taxes, namely corporate income, dividend and capital gains taxes, are vastly dierent due to heterogeneous responses of rms and households, and heterogeneous eects of general equilibrium adjustments. It is indeed important to account for rm heterogeneity in productivity and investment nancing as well as household heterogeneity in age and skill. Overall, taxing capital with a corporate income tax at the rm level results in higher excess burden than taxing capital with dividend and capital gains taxes at the household level. Given the existing U.S. tax treatment for capital income, reforms that shift tax burden from the rm to household side potentially result in eciency gains and overall welfare improving. However, the welfare benets of the tax reforms are quite dierent across households and generations over transition time, depending on skill, age-cohort and budget balancing tax instruments. In particular, majority of currently alive households, especially retirees, experience welfare gains under moderate corporate income tax cuts, but suer from welfare losses under more radical tax cuts.