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Optimal fiscal policy with recursive preferences

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  • Karantounias, Anastasios G.

    ()
    (Federal Reserve Bank of Atlanta)

Abstract

I study optimal capital and labor income taxation in a business cycle model with the recursive preferences of Epstein and Zin (1989) and Weil (1990). In contrast to the case of time-additive expected utility, I find that it is no longer optimal to make the welfare cost of distortionary taxes constant over states and dates. This dramatically alters standard taxation prescriptions: optimal policy calls for taxation at the intertemporal margin, variation of taxation at the intratemporal margin, and persistence of labor taxes independent of the stochastic properties of exogenous shocks. Ignoring the distinction between smoothing over time and smoothing over states is not an innocuous assumption for optimal policy.

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Bibliographic Info

Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2013-07.

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Length: 47 pages
Date of creation: 01 Sep 2013
Date of revision:
Handle: RePEc:fip:fedawp:2013-07

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Keywords: Ramsey plan; Epstein-Zin; recursive utility; risk-sensitive preferences; labor tax; capital tax; martingale;

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  19. Anderson, Evan W., 2005. "The dynamics of risk-sensitive allocations," Journal of Economic Theory, Elsevier, vol. 125(2), pages 93-150, December.
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