For many kinds of capital, depreciation rates change systematically with the age of the capital. Consider an example that captures essential aspects of human capital, both regarding its accumulation and its depreciation: a worker obtains knowledge in period 0, then uses this knowledge in production in periods 1 and 2, and thereafter retires. Here, depreciation accelerates: it occurs at a 100% rate after period 2, and at a lower (perhaps zero) rate before that. The present paper analyzes the implications of non-constant depreciation rates for the optimal timing of taxes on capital income. The main finding is that under natural assumptions, the path of tax rates over time must be oscillatory. Oscillatory tax rates are optimal when depreciation rates accelerate with the age of the capital (as in the above example), and provided that the government can commit to the path of future tax rates but cannot apply different tax rates in a given year to different vintages of capital.
Bibliographical noteFunding Information:
We would like to thank Robert King, one anonymous referee, Katharina Greulich, Heng Chen, and participants to many seminars and conferences for comments. Storesletten—a fellow of CEPR—thanks the Norwegian Research Council for financial support.
- Asset depreciation
- Human capital
- Optimal taxation
- State-contingent taxes
- Tax dynamics