This paper examines the economic and welfare effects of capital gains tax in a productive economy where investment decisions are constrained by the share value of firms. Given that the government budget is balanced each period, with or without lump-sum recourse, I analyze the steady state effects of a swap between capital gains tax and other forms of taxation, including labor income tax and consumption tax. The results indicate that the consumers’ welfare rises with a tax on capital gains in the stock market. This paper also examines the distributional consequence of capital gains tax. In the presence of lump-sum transfers to workers, taxing on capital gains could improve capitalists as well as workers welfare.
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