Optimal Capital Income Taxation with Means-tested Benefits

Cagri Kumru and John Piggott

This paper studies the interaction between capital income taxation and a means tested age pension in the context of an overlapping generations model, calibrated to the UK economy.

Recent literature has suggested a rehabilitation of capital income taxation predicated on the idea that a capital income tax may be a partial substitute for the optimal age-based taxes when they are infeasible. This leads naturally to the conjecture that a publicly funded age pension contingent upon holdings of capital or capital income may have a similar effect. We formalize this using a stochastic OLG model with multiple individuals differentiated by labour productivity and pension entitlements.