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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.

Suggested Citation

  • Scott, Andrew, 1999. "Does Tax Smoothing Imply Smooth Taxes?," CEPR Discussion Papers 2172, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:2172
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    Cited by:

    1. Marcet, Albert & Scott, Andrew, 2009. "Debt and deficit fluctuations and the structure of bond markets," Journal of Economic Theory, Elsevier, vol. 144(2), pages 473-501, March.
    2. 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.
    3. Baltasar Manzano & Jesús Ruiz, 2004. "Política fiscal óptima: el estado de la cuestión," Investigaciones Economicas, Fundación SEPI, vol. 28(1), pages 5-41, January.
    4. Francesco Caprioli & Pietro Rizza & Pietro Tommasino, 2011. "Optimal Fiscal Policy when Agents Fear Government Default," Revue économique, Presses de Sciences-Po, vol. 62(6), pages 1031-1043.
    5. Sleet, Christopher & Yeltekin, Sevin, 2006. "Optimal taxation with endogenously incomplete debt markets," Journal of Economic Theory, Elsevier, vol. 127(1), pages 36-73, March.
    6. Dimitris K. Christopoulos & John Loizides & Efthymios G. Tsionas, 2009. "Electoral Motives, Partisan Motives And Dynamic Optimality With Many Taxes: An International Investigation," Scottish Journal of Political Economy, Scottish Economic Society, vol. 56(1), pages 94-113, February.
    7. Ihtsham Padda, 2014. "On minimizing the welfare cost of fiscal policy: evidence from South Asia," Quality & Quantity: International Journal of Methodology, Springer, vol. 48(3), pages 1553-1572, May.
    8. Ihtsham ul Haq PADDA*, 2010. "On Minimizing the Welfare Cost of Fiscal Policy:Pakistan’s Case," Pakistan Journal of Applied Economics, Applied Economics Research Centre, vol. 20, pages 77-99.

    More about this item

    Keywords

    Fiscal Policy; Incomplete Markets; Optimal Taxation; Tax Smoothing;
    All these keywords.

    JEL classification:

    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H6 - Public Economics - - National Budget, Deficit, and Debt

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