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Distributional effects of public investment when wealth and classes are back

Mattauch, Linus; Edenhofer, Ottmar; Klenert, David Christian; Bénard, Sophie

Inst. Landschaftsarchitektur und Umweltplanung

In developed economies, wealth inequality is high, while public capital is underprovided. Here, we study the impact of heterogeneity in saving behavior and income sources on the distributional effects of public investment. A capital tax is levied to finance productive public capital in an economy with two types of households: high income households who save dynastically and middle income households who save for retirement. We find that inequality is reduced the higher the capital tax rate is and that low tax rates are Pareto-improving. There is no clear-cut trade-off between efficiency and equality: middle income households' consumption is maximal at a capital tax rate that is higher than the rate which maximizes high income households' consumption.