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According to the Chamley-Judd result, capital should not be taxed in the long run. In this paper, we overturn this conclusion, showing that it does not follow from the very models used to derive it. For the main model in Judd (1985), we prove that the long-run tax on capital is positive and significant, whenever the intertemporal elasticity of substitution is below one. For higher elasticities, the tax converges to zero but may do so at a slow rate, after centuries of high tax rates. The main model in Chamley (1986) imposes an upper bound on capital taxes. We provide conditions under which these constraints bind forever, implying positive long-run taxes. When this is not the case, the long-run tax may be zero. However, if preferences are recursive and discounting is locally nonconstant (e.g., not additively separable over time), a zero long-run capital tax limit must be accompanied by zero private wealth (zero tax base) or by zero labor taxes (first-best). Finally, we explain why the equivalence of a positive capital tax with ever-increasing consumption taxes does not provide a firm rationale against capital taxation. (JEL H21, H25)

We develop a theory of endogenous uncertainty where the ability of investors to learn about firm-level fundamentals declines during financial crises. At the same time, higher uncertainty reinforces financial distress of firms, giving rise to "belief traps" - a persistent cycle of uncertainty, pessimistic expectations, and financial constraints, through which a temporary shortage of funds can develop into a long-lasting funding problem for firms. At the macro-level, belief traps can explain why financial crises can result in long-lasting recessions. In our model, financial crises are characterized by high levels of credit misallocation, an increased cross-sectional dispersion of growth rates, endogenously increased pessimism, uncertainty and disagreement among investors, highly volatile asset prices, and high risk premia. A calibration of our model to U.S. micro data on investor beliefs explains a considerable fraction of the slow recovery after the 08/09 crisis. ; The ADEMU Working Paper Series is being supported by the European Commission Horizon 2020 European Union funding for Research & Innovation, grant agreement No 649396.

Rising income inequality since the 1980s in the United States has generated a substantial increase in saving by the top of the income distribution, which we call the saving glut of the rich. The saving glut of the rich has been as large as the global saving glut, and it has not been associated with an increase in investment. Instead, the saving glut of the rich has been linked to the substantial dissaving and large accumulation of debt by the non-rich. Analysis using variation across states shows that the rise in top income shares can explain almost all of the accumulation of household debt held as a financial asset by the household sector. Since the Great Recession, the saving glut of the rich has been financing government deficits to a greater degree.

We propose a theory of indebted demand, capturing the idea that large debt burdens by households and governments lower aggregate demand, and thus natural interest rates. At the core of the theory is the simple yet under-appreciated observation that borrowers and savers differ in their marginal propensities to save out of permanent income. Embedding this insight in a two-agent overlapping-generations model, we find that recent trends in income inequality and financial liberalization lead to indebted household demand, pushing down natural interest rates. Moreover, popular expansionary policies—such as accommodative monetary policy and deficit spending—generate a debt-financed short-run boom at the expense of indebted demand in the future. When demand is sufficiently indebted, the economy gets stuck in a debt-driven liquidity trap, or debt trap. Escaping a debt trap requires consideration of less standard macroeconomic policies, such as those focused on redistribution or those reducing the structural sources of high inequality.