José Miguel Alvarado, University of Queensland

Paper: Capital Taxation and Political Institutions under Aggregate Risk

Abstract: Across countries, more volatile economies levy lower effective capital taxes — with no comparable effect on labor taxes — and the reductions are largest where political institutions are strong. The standard optimal taxation literature cannot account for such variation: under a benevolent planner the long-run capital tax is zero. We show that a neoclassical growth model with a self-interested politician explains this through a precautionary motive: under aggregate risk, the capital tax is lowered optimally to smooth consumption for households and the politician. The mechanism makes a sharper, conditional prediction — the reduction is largest where political institutions are strong, because there the politician’s extraction motive is weakest — which the cross-country evidence confirms.