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Macroeconomic Dynamics


This paper investigates the desirability of constitutional constraints on capital taxation in an environment without government debt and where benevolent governments have limited commitment. In our setup, governments can choose proportional capital and labor income taxes subject to the constitutional constraint but cannot commit to the actual path of taxes. First, we explore a form of constitutional constraint: a constant cap on capital tax rates. In our quantitative exercise, we show that a three per cent cap on capital taxes provides the highest welfare at the worst sustainable equilibrium. However, such cap decreases welfare at the best sustainable equilibrium (both because it constrains feasibility and tightens the incentive compatibility constraint). Second, we identify a form of constitutional constraint that can improve all sustainable equilibria. That constraint features a cap on capital taxes that increases with the level of capital.


This article has been published in a revised form in Macroeconomic Dynamics, This version is free to view and download for private research and study only. Not for re-distribution, re-sale or use in derivative works. © Cambridge University Press 2016.

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