Factor Income Taxation in a Horizontal Innovation Model

We consider the optimal factor income taxation in a standard R&D model with technical change represented by an increase in the variety of intermediate goods. Redistributing the tax burden from labor to capital will in most cases increase the employment rate in equilibrium. This has opposite effects on two distortions in the model, one due to monopoly power, the second to the incomplete appropriability of the benefi ts of inventions. Their relative momentum determines the sign of the welfare effect of the redistribution. We show that, for parameter values consistent with available estimates, the optimal tax rate on capital will be sizable