Optimal tax structure in a two-sector model of endogenous growth

The optimal flat-rate tax structure is calculated in a two-sector endogenous growth model of the US economy. The welfare gains of shifting to the optimal tax mix are much smaller than in the optimal taxation exercises when tax rates are time-varying and confiscatory levels of taxation are possible in the short run. The optimal tax rate on capital income is found to be extremely robust to parameter variations. However, the balance between wage and consumption taxation depends markedly on the tax treatment of goods invested in human capital accumulation and, to a lesser extent, the intertemporal elasticity of substitution. (c) 2006 Elsevier Inc. All rights reserved.