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Optimal Taxation in a Limited Commitment Economy

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  • Yena Park

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    (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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    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. Dirk Krueger & Fabrizio Perri, 2009. "Public versus Private Risk Sharing," NBER Working Papers 15582, National Bureau of Economic Research, Inc.
    2. Andres Erosa & Martin Gervais, 2000. "Optimal taxation in life-cycle economies," Working Paper 00-02, Federal Reserve Bank of Richmond.
    3. DAVILA, Julio & HONG, Jay H. & KRUSELL, Per & RIOS-RULL, José-Victor, . "Constrained efficiency in the neoclassical growth model with uninsurable idiosyncratic shocks," CORE Discussion Papers RP -2463, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
    4. 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.
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    6. Conesa, Juan Carlos & Kitao, Sagiri & Krueger, Dirk, 2006. "Taxing capital? Not a bad idea after all!," CFS Working Paper Series 2006/21, Center for Financial Studies (CFS).
    7. Aiyagari, S Rao, 1995. "Optimal Capital Income Taxation with Incomplete Markets, Borrowing Constraints, and Constant Discounting," Journal of Political Economy, University of Chicago Press, vol. 103(6), pages 1158-75, December.
    8. Timothy J. Kehoe & David K. Levine, 1992. "Debt constrained asset markets," Working Papers 445, Federal Reserve Bank of Minneapolis.
    9. 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.
    10. 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.
    11. Acemoglu, Daron & Golosov, Mikhail & Tsyvinski, Aleh, 2011. "Political economy of Ramsey taxation," Journal of Public Economics, Elsevier, vol. 95(7-8), pages 467-475, August.
    12. Carlos Garriga, 2001. "Optimal Fiscal Policy in Overlapping Generations Models," Working Papers in Economics 66, Universitat de Barcelona. Espai de Recerca en Economia.
    13. Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, MIT Press, vol. 122(3), pages 925-967, 08.
    14. 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.
    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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