Optimal Time-Consistent Taxation with International Mobility Of Capital

The United States relies for its government revenues more on the taxation of capital relative to the taxation of labor than countries in continental Europe do. In this paper we ask what can account for this. Our approach is to look at Markov perfect equilibria of a two-country growth model where both governments use labor, capital and corporate taxes to finance exogenously given streams of public expenditure under period-by-period balanced budget constraints. There is no commitment technology and the equilibrium policies are time-consistent. We find that differences in productivity, size, and government spending can account for the heavy American reliance on capital taxation.