Optimal Capital Income Taxation in an Asymmetric Small Open Economy

This paper examines the structure of the optimal capital income taxation policy for a stochastic small open economy with a financial asymmetry in which the households have access to complete financial markets, while the government is constrained to issue risk-free debt and to announce the capital income tax rate one period in advance. In this setting, the optimal capital income tax rate is nonzero in general. However, with standard restrictions on the production and utility functions, the optimal tax rate on capital income is zero in all periods except the initial one.