We revisit the canonical policy of eliminating capital taxation by increasing labor taxation in a endogenous-labor, heterogeneous-agent model with income and wealth heterogeneity, when the government is subject to a strict (per-period) balanced-budget constraint.By contrast with its non-budget neutral equivalent -associated with a constant tax rate over time and a permanent increase in the level of public debt -we show that the obtained endogenous path for the labor tax rate is sharply increasing in the initial period and decreasing over time.The policy then generates a deeper recession in the short-run and a greater expansion in the long-run, as well as a smaller decline in wealth inequality associated with a reduced incentive to save for precautionary motives.Overall, the policy still generates significant losses in average welfare.

None Dufourt

BUDGET-NEUTRAL CAPITAL TAX CUTS

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