Optimal Taxation When Consumers Have Benchmark Levels of Consumption

Abstract:     
I examine optimal taxes in an overlapping generations economy in which each consumer's utility depends on consumption relative to the average level of consumption in the economy (the benchmark level of consumption) as well as on the level of the consumer's own consumption. The socially optimal balanced growth path is characterized by the Modified Golden Rule and by a condition on the intergenerational allocation of consumption in each period. A competitive economy can be induced to attain the social optimum by a lump-sum pay-as-you-go social security system and a tax on capital income.

Number of Pages in PDF File: 36

Keywords: Benchmark level of consumption, social security, capital income tax

JEL Classification: E21, H31

working papers series