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Optimal Taxes without Commitment

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  • Benhabib, Jess
  • Rustichini, Aldo

Abstract

In the problem of optimal taxation in an economy with two productive factors, labor and capital, the optimal solution when the government can commit to a sequence of tax rates, has the tax on capital tending to zero in the limit, with all the tax burden on labour. It is well known, however, that this solution is time inconsistent; so if the commitment power is not perfect, this second best tax plan will not be suitable. We model explicitly the tradeoff between the cost of revising the tax plan, and the benefit of the revision.
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Suggested Citation

  • Benhabib, Jess & Rustichini, Aldo, 1997. "Optimal Taxes without Commitment," Journal of Economic Theory, Elsevier, vol. 77(2), pages 231-259, December.
  • Handle: RePEc:eee:jetheo:v:77:y:1997:i:2:p:231-259
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    More about this item

    JEL classification:

    • D90 - Microeconomics - - Micro-Based Behavioral Economics - - - General
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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