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Does Tax Smoothing Imply Smooth Taxes?

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  • Scott, Andrew

Abstract

Using a stochastic growth model we derive analytic expressions for optimal labour and capital tax rates under both complete and incomplete markets. We find taxes are driven by two factors reflecting : (a) Ramsey efficiency considerations and (b) the financing needs of the government which vary with the excess burden of taxation. In the case of complete markets the government insures against variations in the excess burden of taxation and taxes change purely for efficiency reasons. The serial correlation and volatility of labour taxes are determined by those of employment and do not necessarily imply smooth tax rates. Under incomplete markets both Ramsey considerations and variations in the excess burden of taxation lead to changes in taxes with the latter providing a unit root component to optimal labour taxes. Using US data we find that the majority of fluctuations in marginal tax rates are due to fluctuations in the excess burden of taxation rather than exploitation of Ramsey considerations.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2172.

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Date of creation: Jun 1999
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Handle: RePEc:cpr:ceprdp:2172

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Keywords: Fiscal Policy; Incomplete Markets; Optimal Taxation; Tax Smoothing;

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Cited by:
  1. Sleet, Christopher & Yeltekin, Sevin, 2006. "Optimal taxation with endogenously incomplete debt markets," Journal of Economic Theory, Elsevier, vol. 127(1), pages 36-73, March.
  2. Marcet, Albert & Scott, Andrew, 2001. "Debt and Deficit Fluctuations and the Structure of Bond Markets," CEPR Discussion Papers 3029, C.E.P.R. Discussion Papers.
  3. Baltasar Manzano & Jess Ruz, 2000. "Optimal Fiscal Policy In A Business Cycle Model: Alternative Identifications Of The Optimal Expost Capital Income Tax Rates," Computing in Economics and Finance 2000 351, Society for Computational Economics.
  4. Baltasar Manzano & Jesús Ruiz, 2002. "Política Fiscal Óptima: el estado de la Cuestión," Documentos del Instituto Complutense de Análisis Económico 0212, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.
  5. Francesco Caprioli & Pietro Rizza & Pietro Tommasino, 2012. "Optimal fiscal policy when agents fear government default," Temi di discussione (Economic working papers) 859, Bank of Italy, Economic Research and International Relations Area.

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