On the Optimal Taxation of Capital Income

function of the after-tax real wage, equation (1.b), no longer applies. It can
be shown that, the relevant version of (2) is
:
t=0
CAPITAL INCOME TAXATION
; t u c(t)[c t&(1&{ n
t)F n(t)]=u c(0)[[F k(0)(1&{ k
0)+1&$] k 0+b 0]. (7)
Since taxation of labor income generates only income effects it is clear
that the optimal tax rate is { n
t =1. If this is the bound on labor taxes, it can
be shown that the result in section 2 holds the limiting capital income tax
rate is zero. To highlight the consequences of less than full taxation of
profits we will make two additional assumptions. First, that there is an
upper bound on the tax rate on labor income given by { n 0 (this is the multiplier corresponding to the resource constraint)
it suffices to show that W k*0. Note that
given F kn>0 (from our assumption that F is concave and homogeneous of
degree one and F kn{0), W k*0. We now show that
*>0.
Proposition 2. Let (c^, x^, k ) be the solution to the unconstrained planner's
problem
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