Optimal Taxation and Constrained Inefficiency in an Infinite-Horizon Economy with Incomplete Markets
European University Institute - Department of Economics; Ca Foscari University of Venice - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute for Economic Research)
Institute of Economic Research, Kyoto University; Singapore Management University
Kyoto University - Institute of Economic Research
August 31, 2011
CESifo Working Paper Series No. 3560
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.
Number of Pages in PDF File: 46
Keywords: incomplete markets, Ramsey equilibrium, optimal taxation, optimal public debt, constrained inefficiency
JEL Classification: D520, D600, D900, E200, E620, H210, O400working papers series
Date posted: September 5, 2011
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