On the optimal capital tax rate in overlapping generations models with capital–skill complementarity

Abstract We show in a medium-scale overlapping-generations model that the optimal capital income tax rate is highly sensitive to the assumption of capital–skill complementarity in production technology. The imposition of the production function of (Krusell et al. in Econometrica, 2000, 68, 1029–1053) rather than the standard Cobb–Douglas function increases the optimal capital tax from 9.2% to 27.3% in our benchmark model. We also study the sensitivity of these results in the context of an aging economy and find that the optimal capital income tax increases over the subsequent decades. With respect to redistributive policies, higher capital taxes are more welfare-improving than are progressive labor income taxes if capital is strongly complementary to skilled labor.