EC4880 Topics in Economics

1.Consider the optimal taxation problem in the Schumpeterianeconomy in Aghion et al (“OptimalCapital versus Labor Taxation with Innovation-Led Growth”, NBER Working Paper, 2013). Usethe calibration and simulation results in the paper to answer the following questions:(a) Consider the optimal long-run tax rate on capital income. Explain why a zero tax on capitalincome is optimal in the neoclassical economy, but it is not optimal in this economy.(b) Explain why there is a positive relationship between theoptimal tax rate on capital incomeand the elasticity of labor supply.(c) Generally speaking, the optimal tax rate on capital income is an increasing function of theshare of government spending. Whenλ= 1, the optimal capital income tax becomes less sensitiveto the increase in the share of government spending (compared with the case whereλ >1). Providethe economic intuition behind these two resultsd) Suppose that the intermediate goods producers have market power (λ >1). Even if theeconomy experiences exogenous growth, the optimal capitalincome tax varies very little withrespect to both the elasticity of labor supply and the share of government spending. Explain.