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Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

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  • Piero Gottardi
  • Atsushi Kajii
  • Tomoyuki Nakajima

Abstract

Should capital and labor be taxed, and if so how when individuals' labor and capital income are subject to uninsurable idiosyncratic risks? In a two period general equilibrium model with production, we first show that reducing investment is welfare improving if households are homogeneous enough ex ante. On the other hand, when the degree of heterogeneity is sufficientlyhigh a welfare improvement is achieved by increasing investment, even if the investment level is already higher than at the e¢ cient allocation obtained when full insurance markets were available. Consequently, the optimal capital tax rate might be negative. We derive a decomposition formula of the e¤ects of the tax which allow us to determine how the sign of optimal tax on capital and labor depends both on the nature of the shocks and the degree of heterogeneity among consumers as well as on the way in which the tax revenue is allocated.

Suggested Citation

  • Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2010. "Constrained Inefficiency and Optimal Taxation with Uninsurable Risks," Economics Working Papers ECO2010/02, European University Institute.
    • Handle: RePEc:eui:euiwps:eco2010/02
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    Cited by:

    1. Nakajima, Tomoyuki & Takahashi, Shuhei, 2017. "The optimum quantity of debt for Japan," Journal of the Japanese and International Economies, Elsevier, vol. 46(C), pages 17-26.
    2. Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2015. "Optimal Taxation and Debt with Uninsurable Risks to Human Capital Accumulation," American Economic Review, American Economic Association, vol. 105(11), pages 3443-3470, November.
    3. Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2010. "Optimal taxation and constrained inefficiency in an infinite-horizon economy with incomplete markets," KIER Working Papers 745, Kyoto University, Institute of Economic Research.
    4. Marco Bassetto & Wei Cui, 2020. "A Ramsey Theory of Financial Distortions," Working Papers 775, Federal Reserve Bank of Minneapolis.
    5. Hisahiro Naito, 2018. "Welfare-improving Consumption Tax in the Presence of Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets," Tsukuba Economics Working Papers 2018-002, Faculty of Humanities and Social Sciences, University of Tsukuba.
    6. YiLi Chien & Yi Wen, 2022. "Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 46, pages 124-160, October.
    7. Yena Park, 2014. "Constrained Efficiency in a Risky Human Capital Model," RCER Working Papers 585, University of Rochester - Center for Economic Research (RCER).
    8. Acikgoz, Omer, 2013. "Transitional Dynamics and Long-run Optimal Taxation Under Incomplete Markets," MPRA Paper 50160, University Library of Munich, Germany.
    9. Li, Meng, 2023. "Loss aversion and inefficient general equilibrium over the business cycle," Economic Modelling, Elsevier, vol. 118(C).
    10. HIRAGUCHI Ryoji, 2023. "Optimal Government Debt Policy in the Overlapping Generations Model with Idiosyncratic Capital Return Risk," Discussion papers 23063, Research Institute of Economy, Trade and Industry (RIETI).
    11. Sigrid Röhrs & Christoph Winter, 2011. "Wealth inequality and the optimal level of government debt," ECON - Working Papers 051, Department of Economics - University of Zurich.
    12. Richard Jaimes, 2021. "Does idiosyncratic risk matter for climate policy?," Vniversitas Económica 19276, Universidad Javeriana - Bogotá.
    13. Sakai Ando, 2017. "Size-Dependent Policies and Efficient Firm Creation," ISER Discussion Paper 1033, Institute of Social and Economic Research, Osaka University, revised Jun 2018.
    14. Ando, Sakai & Matsumura, Misaki, 2020. "Constrained inefficiency of competitive entrepreneurship," Journal of Mathematical Economics, Elsevier, vol. 88(C), pages 98-103.

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    More about this item

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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