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Optimal Taxation in a Limited Commitment Economy

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  • Yena Park

    () (Department of Economics, University of Pennsylvania)

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    Abstract

    This paper studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labor because individuals do not take into account that their labor and saving decisions affect aggregate supply, wages and thus the value of autarky. Due to these externalities, the Ramsey government has an additional goal, which is to internalize the externalities of labor and capital to improve risk sharing, in addition to its usual goal - minimizing distortions when financing government expenditures. These two goals drive capital and labor taxes in opposite directions. By balancing these conflicting goals, the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, and optimal labor income taxes are set to meet the budgetary needs of the government in the long run, despite positive externalities of labor.

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    File URL: http://economics.sas.upenn.edu/system/files/12-033.pdf
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    Bibliographic Info

    Paper provided by Penn Institute for Economic Research, Department of Economics, University of Pennsylvania in its series PIER Working Paper Archive with number 12-033.

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    Length: 51 pages
    Date of creation: 28 Aug 2012
    Date of revision:
    Handle: RePEc:pen:papers:12-033

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    Keywords: Ramsey Taxation; Limited Enforcement;

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    1. Andrés Erosa & Martin Gervais, 1998. "Optimal Taxation in Life-Cycle Economies," UWO Department of Economics Working Papers 9812, University of Western Ontario, Department of Economics.
    2. S. Rao Aiyagari, 1994. "Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting," Working Papers 508, Federal Reserve Bank of Minneapolis.
    3. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal Fiscal Policy in a Business Cycle Model," NBER Working Papers 4490, National Bureau of Economic Research, Inc.
    4. Kehoe, Timothy J & Levine, David K, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 865-88, October.
    5. Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 122(3), pages 925-967, 08.
    6. Conesa, Juan Carlos & Krüger, Dirk, 2005. "On the Optimal Progressivity of the Income Tax Code," CEPR Discussion Papers 5040, C.E.P.R. Discussion Papers.
    7. Juan C. Conesa & Dirk Krueger, 2004. "Taxing Capital: Not a Bad Idea After All," 2004 Meeting Papers 403, Society for Economic Dynamics.
    8. Daron Acemoglu & Michael Golosov & Aleh Tsyvinski, 2008. "Political Economy of Ramsey Taxation," Levine's Working Paper Archive 122247000000002192, David K. Levine.
    9. Julio Davila & Jay H. Hong & Per Krusell & Jose-Victor Rios-Rull, 2005. "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," PIER Working Paper Archive 05-023, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    10. Jonathan Heathcote & Kjetil Storesletten & Giovanni L. Violante, 2009. "Consumption and labor supply with partial insurance: an analytical framework," Staff Report 432, Federal Reserve Bank of Minneapolis.
    11. Dirk Krueger & Fabrizio Perri, 2009. "Public versus Private Risk Sharing," NBER Working Papers 15582, National Bureau of Economic Research, Inc.
    12. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    13. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc.
    14. Carlos Garriga, 2001. "Optimal Fiscal Policy in Overlapping Generations Models," Working Papers in Economics 66, Universitat de Barcelona. Espai de Recerca en Economia.
    15. Abraham, Arpad & Carceles-Poveda, Eva, 2006. "Endogenous incomplete markets, enforcement constraints, and intermediation," Theoretical Economics, Econometric Society, vol. 1(4), pages 439-459, December.
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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Taxation in a Limited Commitment Economy
      by Christian Zimmermann in NEP-DGE blog on 2012-09-11 16:52:10

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