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Optimal Taxation with Endogenous Insurance Markets

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Author Info
Tsyvinski, A.
Golosov, M.

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Abstract

In this paper, we study optimal tax policy in a dynamic private information economy. We describe efficient allocations and competitive equilibria. The standard assumption in the literature is that trades are observable by all agents. We show that in such an environment the competitive equilibrium is efficient and that government consumption can be financed by lump-sum taxation. We go on to consider an environment with unobservable trades in competitive markets. We show that efficient allocations have the property that the marginal product of capital is different from the market interest rate associated with unobservable trades. In any competitive equilibrium without taxation, the marginal product of capital and the market interest rate are equated, so that competitive equilibria are not efficient. Taxation of capital income can be welfare-improving because such taxation introduces a wedge between market interest rates and the marginal product of capital and allows agents to obtain better insurance in private markets. We use plausibly calibrated numerical examples to compute optimal taxes and welfare gains and compare results to an economy with a restricted set of tax instruments, and to an economy with observable trades

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Publisher Info
Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 124.

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Date of creation: 2004
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Handle: RePEc:red:sed004:124

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Related research
Keywords: Optimal Dynamic Taxation; Social Insurance;

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Find related papers by JEL classification:
E01 - Macroeconomics and Monetary Economics - - General - - - Measurement and Data on National Income and Product Accounts and Wealth

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