Abstract
Many recent studies have argued that it is useful to introduce a third input into the neoclassical production technology which encapsulates the productivity enhancing knowledge created in the process of production. This input, often called organizational capital, has been shown to improve the predictions of dynamic general equilibrium models, especially at the business cycle frequency. In this paper, we study the impact of organizational capital on optimal taxation in the Ramsey tradition and find that the planner would behave quite differently in the presence of organizational capital than in its absence. We use simulations to show that the optimal capital income tax is different from zero in environments where earlier models predicted zero taxes or even subsidies. In the model, both capital and labor taxes distort the accumulation of organizational capital and the planner must trade off these dynamic distortions to fund the obligations of the government. As a result, the planner chooses a positive tax on labor and capital. Generally the tax on labor income is lower while that on capital income is higher than predicted in the absence of organizational capital.
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Notes
See Alvarez et al. (1992), Erosa and Gervais (2002) for life cycle models, where the tax code cannot be explicitly conditioned on the age of the household and Hubbard and Judd (1987), and Aiyagari (1995) for the latter. Using Bewley (1986) class of models, Aiyagari (1995) shows that if households face tight borrowing constraints and are subject to uninsurable idiosyncratic income risk, then the optimal tax system will in general include a positive capital income tax.
We use a model with imperfect competition in goods markets, both because this is a natural environment for firms with OC previously analyzed in the literature and also because it raises the bar on finding positive capital taxes.
See Jones et al. (1997) for details on this point.
Our use of the timeless perspective eliminates the possibility of taxing the initial stock of capital which could provide, in principle, a non-distortionary source of revenue to the government.
We normalize the final good’s price, \(p_t\), to 1
This symmetry is also a reason why we model OC as accumulating using labor as an input rather than output as in Clarke and Johri (2009).
Note that physical capital accumulation has a symmetric structure. Next period capital is the sum of the undepreciated stock of physical capital and the new capital produced in this period which is a fraction of output, itself produced by a combination of labor and the current stock of physical capital.
All input payments are assumed to be made in units of the final good.
Combining (5) and (8), we get the pricing formula for a one-period risk-free real bond \(1= R_t \frac{\beta u_{c,t+1}}{u_{ct}}\), which implies the following real pricing kernel between period t and \(t + 1\):
$$\begin{aligned} Q_{t+1}= \frac{\beta u_{c,t+1}}{u_{ct}}. \end{aligned}$$Consumer’s discount factor is appropriate to discount period \(t+1\) profit because they own all intermediate firms and thus receive all the profits.
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Acknowledgements
We thank Marc-André Letendre, William Scarth, Katherine Cuff, and participants in seminars at several universities and conferences for insightful comments.
Funding
Social Science and Humanities Research Council of Canada (Grant no. 410-2008-0786).
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Johri, A., Talukdar, B. Organizational capital and optimal Ramsey taxation. Ind. Econ. Rev. 58 (Suppl 1), 193–210 (2023). https://doi.org/10.1007/s41775-023-00163-2
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DOI: https://doi.org/10.1007/s41775-023-00163-2