Optimal Capital Taxation, Labour Unions, and the Hold-Up Problem

This document examines optimal capital taxation with wage‐setting labour unions when the government taxes consumption, labour, and capital. The results are as follows. If unions can commit themselves to particular wages for a long period, then there is no hold‐up problem. Otherwise, the hold‐up problem creates a positive link from capital accumulation to the wage. The optimal labour subsidy is positive and greater in the presence than in the absence of the hold‐up problem. The optimal capital subsidy is zero in the absence, but positive in the presence of the hold‐up problem.