Optimal Taxation and Constrained Inefficiency in an Infinite-Horizon Economy with Incomplete Markets
CESifo, Munich, 2011
CESifo Working Paper No. 3560
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We study the dynamic Ramsey problem of finding optimal public debt and linear taxes on capital and labor income within a tractable infinite horizon model with incomplete markets. With zero public expenditure and debt, it is optimal to tax the risky labor income and subsidize capital, while a positive amount of public debt is welfare improving. A steady state optimality condition is derived which implies that the tax on capital is positive, when savings are sufficiently inelastic to returns. A calibration of our model to the US economy indicates positive optimal taxes and a small but positive optimal debt level.
Fiscal Policy, Macroeconomics and Growth
Empirical and Theoretical Methods