Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

28 Pages Posted: 4 Apr 2015

See all articles by Piero Gottardi

Piero Gottardi

University of Essex - Department of Economics; European University Institute - Department of Economics; Ca Foscari University of Venice - Dipartimento di Economia; CESifo (Center for Economic Studies and Ifo Institute)

Atsushi Kajii

Institute of Economic Research, Kyoto University; Singapore Management University

Tomoyuki Nakajima

University of Tokyo

Date Written: November 2014

Abstract

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so, how? In a two-period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This method allows us to determine how the sign of the optimal taxes on capital and labor depends on the nature of the shocks, the degree of heterogeneity among consumers' income, and the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases, a negative tax on capital improves welfare.

Keywords: optimal linear taxes, incomplete markets, constrained efficiency

JEL Classification: D52, H21

Suggested Citation

Gottardi, Piero and Kajii, Atsushi and Nakajima, Tomoyuki, Constrained Inefficiency and Optimal Taxation with Uninsurable Risks (November 2014). FRB Atlanta Working Paper No. 2014-25, Available at SSRN: https://ssrn.com/abstract=2580468 or http://dx.doi.org/10.2139/ssrn.2580468

Piero Gottardi

University of Essex - Department of Economics ( email )

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

European University Institute - Department of Economics ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Ca Foscari University of Venice - Dipartimento di Economia ( email )

Cannaregio 873
Venice, 30121
Italy
+39 041 257 4192 (Phone)
+39 041 257 4176 (Fax)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Atsushi Kajii

Institute of Economic Research, Kyoto University ( email )

Yoshida-Honmachi
Sakyo-ku
Kyoto 606-8501
JAPAN

HOME PAGE: http://www.kier.kyoto-u.ac.jp/~kajii/

Singapore Management University ( email )

School of Economics
90 Stamford Road
Singapore, 178903
Singapore

Tomoyuki Nakajima (Contact Author)

University of Tokyo ( email )

Yayoi 1-1-1
Bunkyo-ku
Tokyo, Tokyo 113-8657
Japan

HOME PAGE: http://https://sites.google.com/view/tomoyukinakajima/home

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