Taxing Capital in the Presence of Trickle Down Effects : A Sufficient Statistics Approach

Within a rich dynamic environment I derive a robust and testable condition for the optimality of capital income tax rates. I apply this condition to US data. Endogenous responses of factor prices mitigate welfare gains of capital tax increases for a large fraction of the population, who derives most of its disposable income from net wages. However, due to a positive revenue impact, the same price responses amplify the welfare gains of the very bottom of the income distribution, whose main income source are government transfers. As a consequence, general equilibrium forces may increase the optimal capital tax rate relative to its exogenous price counterpart, contradicting conventional wisdom