Optimal Taxation of Capital Income in a Growth Model with Monopoly Profits

This paper shows that the optimal steady-state tax on capital income in a neoclassical growth model can be positive, negative, or zero, depending crucially on the level of monopoly profits and the degree to which profits can be taxed. With an empirically plausible level of profits, the model implies that the optimal steady-state tax on capital can range between -6 percent and 24 percent, depending on the structure of dividend taxation. Similarly, we find that the available welfare gain of switching from the existing U.S. tax policy to a revenue-neutral optimal tax policy can range between 0.8 percent and 3.9 percent of steady-state output.