The Welfare Cost of Capital Income Taxation in a Growing Economy

The welfare cost of capital income taxation is analyzed in a general equilibrium framework, where the private sector is represented by a competitive household endowed with perfect foresight and an infinite life. The value of the welfare cost depends essentially on the elasticity of substitution between capital and labor in the production function. Numerical estimates are presented for different values of the parameters of the model. The welfare gain obtained by the abolition of the capital income tax is smaller when the private sector is not endowed with perfect foresight (it is reduced by about 40 percent when expectations are myopic). The allocation efficiency cost of the corporate tax dwarfs the intertemporal welfare cost.