Redistribution, capital income taxation and tax evasion

Abstract

Factor mobility and tax evasión are two phenomena that constraint the effectiveness of redistributive policies now used by the member countries of the European Union. In this paper, a normative analysis of this fact is undertaken using a simple model with two countries and two social classes, where capital is perfectly mobile and labour is immobile. Each country complements the income of its workers, assumed to be poor, with transfers. The latter are financed with two taxes on capital income. The first one, following the origin principie, alters the retum and intemational allocation of capital. The second one, following the residence principie, induces the evasión of capitalists' incomes. Each government chooses the optimal mix of capital taxes that maximizes the welfare of its citizens with no regard on the repercussions on its neighbour country. A numerical exercise is built to examine the sensitivity of the resulting non cooperative equilibrium to the aversión to inequality exhibited by the different governments as well as to the factor endowments of their respective countries.