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Taxation without commitment

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  • Catarina Reis

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Abstract

This paper considers a Ramsey model of linear capital and labor income taxation in which a benevolent government cannot commit ex-ante to a sequence of policies for the future. In this setup, if the government is forced to keep budget balance in every period, then it may not be able to sustain zero capital taxes in the long run, as shown in Benhabib and Rustichini (J Econ Theory 77:231–259, 1997 ) and Phelan and Stachetti (Econometrica 69:1491–1518, 2001 ). However, (Dominguez in J Econ Theory 135:159–170, 2007 ) shows that if the government is allowed to borrow and lend to households, the optimal capital income tax still converges to zero in the long run, as long as the value of defaulting is independent of the level of government debt. This paper provides a game theoretic setup with government debt where the value of the worst equilibrium only depends on the initial level of capital and can be determined in advance. This implies that under our assumptions the best sustainable equilibrium has zero capital taxes in the long run, even in the absence of government commitment. Copyright Springer-Verlag 2013

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File URL: http://hdl.handle.net/10.1007/s00199-011-0656-0
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Bibliographic Info

Article provided by Springer in its journal Economic Theory.

Volume (Year): 52 (2013)
Issue (Month): 2 (March)
Pages: 565-588

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Handle: RePEc:spr:joecth:v:52:y:2013:i:2:p:565-588

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Related research

Keywords: Fiscal policy; Optimal taxation; Debt; Game theory; E62; H21; H63; C7;

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  1. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
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  8. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November.
  9. Judd, Kenneth L., 1985. "Redistributive taxation in a simple perfect foresight model," Journal of Public Economics, Elsevier, vol. 28(1), pages 59-83, October.
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  14. Narayana Kocherlakota, 2010. "Implications of Efficient Risk Sharing Without Commitment," Levine's Working Paper Archive 2053, David K. Levine.
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  17. Christopher Phelan & Ennio Stacchetti, 1999. "Sequential equilibria in a Ramsey tax model," Staff Report 258, Federal Reserve Bank of Minneapolis.
  18. Benhabib, Jess & Rustichini, Aldo, 1997. "Optimal Taxes without Commitment," Journal of Economic Theory, Elsevier, vol. 77(2), pages 231-259, December.
  19. Jorge Soares, Marina Azzimonti, Pierre-Daniel Sarte & Pierre-Daniel Sarte & Jorge Soares, 2006. "Optimal Policy and (the Lack of) Time Inconsistency: Insights from Simple Models," Working Papers 06-08, University of Delaware, Department of Economics.
  20. Mark Aguiar & Manuel Amador & Gita Gopinath, 2006. "Efficient expropriation: sustainable fiscal policy in a small open economy," Working Papers 06-9, Federal Reserve Bank of Boston.
  21. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  22. Klein, Paul & Krusell, Per & Ríos-Rull, José-Víctor, 2004. "Time Consistent Public Expenditures," CEPR Discussion Papers 4582, C.E.P.R. Discussion Papers.
  23. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-32, May.
  24. Klein Paul & Quadrini Vincenzo & Rios-Rull Jose-Victor, 2005. "Optimal Time-Consistent Taxation with International Mobility Of Capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-36, June.
  25. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
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