Capital Taxes, Labor Taxes and the Household

Paper number: 14/13

Paper date: July 2014

Year: 2014

Paper Category: Discussion Paper

Authors

Rigas Oikonomou and Christian Siegel

Abstract

We study the impact of capital and labor taxation in an economy where couples bargain over the intrahousehold allocation. We present a life cycle model with heterogeneous individuals and incomplete financial markets. Drawing from the literature of the collective framework of household behavior, we model decision making within the couple as a contract under limited commitment. In this framework more wealth improves commitment and gives rise to insurance gains within the household. Our theory motivates these gains by the empirical observation that wealth, in contrast to labor income, is a commonly held resource within households. Based on this observation we study whether eliminating capital taxes from the economy, and raising labor taxes to balance the government's budget, may generate welfare gains to married households. We illustrate that the quantitative effects from this reform are rather small. We attribute the small effects to the life cycle pattern of wealth accumulation and to the impact of labor income taxes on household risk sharing: In particular, we show that higher labor taxes may deteriorate the limited commitment problem, even though they may make the distribution of labor income more equitable within the household.

JEL codes: D13, D52, E21, E62, H31

Keywords: Life cycle models, incomplete nancial markets, tax reform, intrahousehold allocations

Capital Taxes, Labor Taxes and the Household Capital Taxes, Labor Taxes and the Household