Optimal capital taxation and precautionary savings

There are multiple reasons to motivate the role of capital taxation in the heterogenous-agent incomplete-markets (HAIM) model. One is the production inefficiency caused by precautionary savings. The other is the wealth redistribution role played by capital taxation. To distinguish between these two reasons, this article uses an analytical tractable HAIM model with a degenerated distribution of wealth while preserving the role of precautionary savings. The degenerated wealth distribution shuts down the distributional role played by capital taxation. Our results show that, with no role to play for redistribution, the government bond is more suitable than capital tax for addressing the production inefficiency caused by households’ precautionary savings in the HAIM model. (JEL C61, E22, E62, H21, H30).