The Inconsistency Puzzle Resolved: an Omitted Variable
AbstractThe contemporary version of the dynamic Ramsey problem omits expectations of a household’s initial lump-sum wealth taxation due to policy revision; therefore, the attainable resource allocation set in this problem is ill-defined. This omission leads to misleading conclusions about the optimal policy in the short run and, in particular, that the Ramsey policy is dynamically inconsistent. The effect of introducing the expectations into the analysis of dynamic inconsistency is similar to that of introducing expected inflation into the Phillips curve: we show that only an unexpected policy surprise affects the attainable resource allocation set and the optimal policy. In contrast to Chamley (1986), we show that intensive capital income taxation at the beginning of an optimal policy does not imply a lump-sum taxation of household wealth and cannot reduce the excess tax burden. We also demonstrate that the Ramsey policy is dynamically consistent even without commitment. We resolve the Ramsey problem and compare our results to those of Chamley on optimal capital income taxation.
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Bibliographic InfoPaper provided by Economics and Econometrics Research Institute (EERI), Brussels in its series EERI Research Paper Series with number EERI_RP_2008_15.
Length: 31 pages
Date of creation: 26 Oct 2008
Date of revision:
Consistency; Equilibrium policy; Optimal taxation;
Other versions of this item:
- Arefiev, Nikolay, 2008. "The Inconsistency Puzzle Resolved: an Omitted Variable," MPRA Paper 9300, University Library of Munich, Germany.
- E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2008-11-18 (All new papers)
- NEP-DGE-2008-11-18 (Dynamic General Equilibrium)
- NEP-MAC-2008-11-18 (Macroeconomics)
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