Is there a majority to support a capital tax cut? Franois Gourio September 2008 Abstract A capital income tax cut must in general be nanced by increasing other taxes, and thus will have redistributive e/ects. This paper studies analytically the redistribution implied by a capital income tax cut in the Ramsey-Cass-Koopmans neoclassical growth model when agents di/er in wealth and human capital and markets are frictionless. A few parameters a/ect the e¢ciency benets and redistributive costs of capital taxation, and determine the set of agents who are in favor of a capital income tax cut. For plausible parameter values, a majority would lose from the tax cut, i.e. high capital taxes may be politically sustainable. 1 Introduction Chamley (1986) and Judd (1985) discovered that in the neoclassical growth model, the optimal capital income tax rate is zero in steady-state. This result is robust to several extensions, as discussed in Atkeson, Chari and Kehoe (1999). However, in the real world, governments still levy substantial taxes on capital income: for instance, Lucas (1990) and Mulligan (2004) estimate a capital income tax rate between 30% and 40% for the United States today. This raises the question, why dont we have lower capital income tax rates? Possible explanations include that economies have not reached the steady- state, that governments have limited commitment, or that markets are incomplete. This paper explores the hypothesis that capital income tax cuts benet only a minority and are thus unlikely to arise in a median-voter economy. The main contribution of the paper is to present a simple analytical formula which determines which agents benet from a capital income tax cut that is nanced by increased labor income taxes. I use a version of the Ramsey-Cass-Koopmans neoclassical growth model, with agents heterogeneous in nancial wealth and xed human capital and perfect credit markets. The paper considers the following experiment: starting at time 0 in a steady-state, the government cuts innitesimally the tax rate on capital - and keeps it constant thereafter - while increasing the tax rate on labor to maintain the present-value budget balance. The analytical results allow to conduct simple comparative statics exercises, and to use this formula as a theory of the tax rate that will prevail in a society where consumers vote to decide the tax structure: the median voter must be indi/erent between Boston University, Department of Economics, 270 Bay State Road, Boston MA 02215. Email: fgourio@bu.edu. I thank Fernando Alvarez, Robert E. Lucas Jr., Casey B. Mulligan, and anonymous referees for helpful comments. 1