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Ramsey Meets Hosios: The Optimal Capital Tax and Labor Market Efficiency

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  • David M. Arseneau

    (Federal Reserve Board)

  • Sanjay K. Chugh

    (Federal Reserve Board)

Abstract

Heterogeneity between unemployed and employed individuals matters for optimal fiscal policy. This paper considers the consequences of such heterogeneity for the determination of optimal capital and income taxes in a model with matching frictions in the labor market. In line with a recent finding in the literature, we find that the optimal capital tax is typically non-zero because it is used to indirectly mitigate and externality that arises from search and matching frictions, one that cannot be corrected by the labor tax. However, the consideration of heterogeneity makes our results differ in an important way: even for a well-known parameter configuration that typically eliminates this externality, we continue to find a non-zero optimal capital tax. This difference stems from heterogeneity in welfare between the employed and the unemployed that gives rise to an insider/outsider problem in wage bargaining. An employed individual does not internalize how the outcome of wage negotiations affects the welfare of the unemployed, while the Ramsey planner does internalize this effect

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2006 with number 222.

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Date of creation: 04 Jul 2006
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Handle: RePEc:sce:scecfa:222

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Keywords: Optimal fiscal policy; Labor market search;

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References

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  1. Kenneth L. Judd, 2002. "Capital-Income Taxation with Imperfect Competition," American Economic Review, American Economic Association, vol. 92(2), pages 417-421, May.
  2. Sanjay K. Chugh, 2005. "Optimal fiscal and monetary policy with sticky wages and sticky prices," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 834, Board of Governors of the Federal Reserve System (U.S.).
  3. Christophe Chamley, 1980. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Cowles Foundation Discussion Papers 553, Cowles Foundation for Research in Economics, Yale University.
  4. David Domeij, 2005. "Optimal Capital Taxation and Labor Market Search," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 8(3), pages 623-650, July.
  5. Oliver Jean Blanchard & Peter Diamond, 1989. "The Beveridge Curve," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1), pages 1-76.
  6. Stephanie Schmitt-Grohé & Martín Uribe, 2006. "Optimal Fiscal and Monetary Policy in a Medium-Scale Macroeconomic Model," NBER Chapters, in: NBER Macroeconomics Annual 2005, Volume 20, pages 383-462 National Bureau of Economic Research, Inc.
  7. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, Elsevier, vol. 12(1), pages 55-93.
  8. Merz, Monika, 1995. "Search in the labor market and the real business cycle," Journal of Monetary Economics, Elsevier, Elsevier, vol. 36(2), pages 269-300, November.
  9. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report, Federal Reserve Bank of Minneapolis 251, Federal Reserve Bank of Minneapolis.
  10. Walsh, Carl E., 2003. "Labor Market Search, Sticky Prices, and Interest Rate Policies," Santa Cruz Center for International Economics, Working Paper Series, Center for International Economics, UC Santa Cruz qt6tg550dv, Center for International Economics, UC Santa Cruz.
  11. Thomas Lubik & Michael Krause, 2003. "The (Ir)relevance of Real Wage Rigidity in the New Keynesian Model with Search Frictions," Economics Working Paper Archive 504, The Johns Hopkins University,Department of Economics.
  12. Antonella Trigari, 2009. "Equilibrium Unemployment, Job Flows, and Inflation Dynamics," Journal of Money, Credit and Banking, Blackwell Publishing, Blackwell Publishing, vol. 41(1), pages 1-33, 02.
  13. Richard Rogerson & Robert Shimer & Randall Wright, 2004. "Search-Theoretic Models of the Labor Market-A Survey," NBER Working Papers 10655, National Bureau of Economic Research, Inc.
  14. Shi, Shouyong & Wen, Quan, 1999. "Labor market search and the dynamic effects of taxes and subsidies," Journal of Monetary Economics, Elsevier, Elsevier, vol. 43(2), pages 457-495, April.
  15. Andolfatto, David, 1996. "Business Cycles and Labor-Market Search," American Economic Review, American Economic Association, vol. 86(1), pages 112-32, March.
  16. Hosios, Arthur J, 1990. "On the Efficiency of Matching and Related Models of Search and Unemployment," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 57(2), pages 279-98, April.
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Cited by:
  1. Arseneau, David M. & Chugh, Sanjay K., 2008. "Optimal fiscal and monetary policy with costly wage bargaining," Journal of Monetary Economics, Elsevier, Elsevier, vol. 55(8), pages 1401-1414, November.
  2. David M. Arseneau & Sanjay K. Chugh, 2012. "Tax Smoothing in Frictional Labor Markets," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 120(5), pages 926 - 985.
  3. Sanjay K. Chugh, 2006. "Optimal Fiscal and Monetary Policy with Sticky Wages and Sticky Prices," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 683-714, October.
  4. Carl Walsh, 2007. "Inflation Targeting and the Role of Real Objectives," Research and Policy Notes 2007/02, Czech National Bank, Research Department.
  5. David M. Arseneau & Ryan Chahrour & Sanjay K. Chugh & Alan Finkelstein Shapiro, 2013. "Optimal Fiscal and Monetary Policy in Customer Markets," Boston College Working Papers in Economics 842, Boston College Department of Economics.
  6. Brecher, Richard A. & Chen, Zhiqi & Choudhri, Ehsan U., 2010. "A dynamic model of shirking and unemployment: Private saving, public debt, and optimal taxation," Journal of Economic Dynamics and Control, Elsevier, Elsevier, vol. 34(8), pages 1392-1402, August.
  7. David M. Arseneau & Sanjay K. Chugh, 2007. "Bargaining, fairness, and price rigidity in a DSGE environment," International Finance Discussion Papers, Board of Governors of the Federal Reserve System (U.S.) 900, Board of Governors of the Federal Reserve System (U.S.).
  8. Jung, Philip, 2007. "Optimal Taxation and (Female)-Labor Force Participation over the Cycle," MPRA Paper 8744, University Library of Munich, Germany, revised 13 May 2008.
  9. Sanjay K. Chugh & Andre Kurmann & David M. Arseneau, 2009. "Optimal Capital Taxation in an Economy with Capital Allocation Frictions," 2009 Meeting Papers, Society for Economic Dynamics 147, Society for Economic Dynamics.

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