Optimal Capital Taxation with Labor Unions
Abstract
In this paper, I examine the nature of optimal capital taxation in an economy where labor unions set wages. Wage contracts are called binding, if they protect investors against immediate expropriation after new machines are installed. I show that in order to maintain aggregate production efficiency the government needs a labor tax only in the presence and taxes on both labor and capital in the absence of binding contracts. In addition, I construct optimal tax rules for the cases of both binding and non-binding wage contracts.