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Optimal dynamic tax-transfer policies in heterogeneous-agents economies

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  • Chien, YiLi
  • Wen, Yi

Abstract

When designing an optimal tax-transfer system, the existing literature identifies two key factors: labor efficiency and debt efficiency. The labor-efficiency approach emphasizes the trade-off between redistribution and distortion in the labor market, while the debt-efficiency approach emphasizes the trade-off between monopoly rent gains and distortion in the asset market. In this paper, we propose a third factor to consider when designing optimal tax-transfer policies: the dynamic-efficiency approach. To demonstrate this, we use an analytically tractable infinite-horizon model incorporating both ex-ante and ex-post heterogeneity. We show that the optimal tax-transfer system is determined at the point where the intertemporal wedge between the market interest rate and the time discount rate is fully eliminated, regardless of the Laffer curve, provided the government’s fiscal space allows for an interior Ramsey steady state. Therefore, in line with recent findings by Chien and Wen (2024), incorporating dynamic efficiency could potentially transform the structure of optimal tax-transfer policies within an infinite-horizon model featuring heterogeneous agents.

Suggested Citation

  • Chien, YiLi & Wen, Yi, 2026. "Optimal dynamic tax-transfer policies in heterogeneous-agents economies," European Economic Review, Elsevier, vol. 186(C).
    • Handle: RePEc:eee:eecrev:v:186:y:2026:i:c:s0014292126000644
    DOI: 10.1016/j.euroecorev.2026.105320
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