Capital Taxation in a Large Open Economy

This paper examines the effects of capital taxation in a large open economy, using an overlapping generations model with adjustment costs in capital installation. Taxes on returns on savings and on profits are considered. It is shown that the introduction of taxes will reduce the capital stock in the home country, regardless of the current account balance. It is also shown that if the country has these taxes initially, then a profit tax increases may raise the capital labor ratio and the wage rate, reducing the foreign asset holdings in the home country