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Constrained Inefficiency and Optimal Taxation with Uninsurable Risks

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  • PIERO GOTTARDI
  • ATSUSHI KAJII
  • TOMOYUKI NAKAJIMA

Abstract

When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so, how? In a two-period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This method allows us to determine how the sign of the optimal taxes on capital and labor depends on the nature of the shocks, the degree of heterogeneity among consumers' income, and the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases, a negative tax on capital improves welfare.
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Suggested Citation

  • Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2016. "Constrained Inefficiency and Optimal Taxation with Uninsurable Risks," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 18(1), pages 1-28, February.
    • Handle: RePEc:bla:jpbect:v:18:y:2016:i:1:p:1-28
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    File URL: http://hdl.handle.net/10.1111/jpet.2016.18.issue-1
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    Cited by:

    1. Li, Meng, 2023. "Loss aversion and inefficient general equilibrium over the business cycle," Economic Modelling, Elsevier, vol. 118(C).
    2. Nakajima, Tomoyuki & Takahashi, Shuhei, 2017. "The optimum quantity of debt for Japan," Journal of the Japanese and International Economies, Elsevier, vol. 46(C), pages 17-26.
    3. Sakai Ando, 2018. "Size-Dependent Policies and Efficient Firm Creation," ISER Discussion Paper 1033, Institute of Social and Economic Research, The University of Osaka.
    4. Ando, Sakai & Matsumura, Misaki, 2020. "Constrained inefficiency of competitive entrepreneurship," Journal of Mathematical Economics, Elsevier, vol. 88(C), pages 98-103.
    5. Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2015. "Optimal Taxation and Debt with Uninsurable Risks to Human Capital Accumulation," American Economic Review, American Economic Association, vol. 105(11), pages 3443-3470, November.
    6. Piero Gottardi & Atsushi Kajii & Tomoyuki Nakajima, 2010. "Optimal taxation and constrained inefficiency in an infinite-horizon economy with incomplete markets," KIER Working Papers 745, Kyoto University, Institute of Economic Research.
    7. repec:upd:utppwp:075 is not listed on IDEAS
    8. Shuichi Tsugawa, 2024. "Optimal redistributive policy under disaster risk: self-protection, social mitigation and social adaptation," Working Papers e203, Tokyo Center for Economic Research.
    9. Sigrid Röhrs & Christoph Winter, 2011. "Wealth inequality and the optimal level of government debt," ECON - Working Papers 051, Department of Economics - University of Zurich.
    10. Hisahiro Naito, 2018. "Welfare-improving Consumption Tax in the Presence of Wage Tax under Idiosyncratic Returns from Investment and Incomplete Markets," Tsukuba Economics Working Papers 2018-002, Faculty of Humanities and Social Sciences, University of Tsukuba.
    11. Yena Park, 2014. "Constrained Efficiency in a Risky Human Capital Model," RCER Working Papers 585, University of Rochester - Center for Economic Research (RCER).
    12. Acikgoz, Omer, 2013. "Transitional Dynamics and Long-run Optimal Taxation Under Incomplete Markets," MPRA Paper 50160, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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