Capital taxation

This paper provides and employs a simple method for evaluating the quantitative importance of distorting savings in Mirrleesian private-information settings. Our exercise takes any baseline allocation for consumption - from US data or a calibrated equilibrium model using current policy - and solves for the best reform that ensures preserving incentive compatibility. The Inverse Euler equation holds at the new optimized allocation. Our method provides a simple way to compute the welfare gains and optimized allocation - indeed, yielding closed form solutions in some cases. When we apply it, we find that welfare gains may be quite significant in partial equilibrium, but that general equilibrium considerations mitigate the gains significantly. In particular, starting with the equilibrium allocation from Aiyagari's incomplete market model yields small welfare gains. Keywords: Capital taxation, inverse Euler equation, constrained efficient, Chamley-Judds. JEL Classifications: E6, H2.