Optimal taxes for Europe and the U.S. are derived in a realistically calibrated model in which agents buy consumption goods and services and use home capital and labor to produce household services. The optimal tax rate on services is substantially lower than the tax rate on goods. Specifically, the planner cannot tax home production directly and instead lowers the tax rate on market services to increase the relative price of home production. The optimal tax rate on the return to home capital is strictly positive and the welfare gains from switching to optimal taxes are large.
Optimal Taxation Household Production Time Allocation Labor Supply