The Welfare Effects of Uncertain Tax Policies

Uncertainty about tax policies affects both individual behavior: to work, to save, and to spend and economic welfare of a representative consumer-taxpayer. In this paper, unlike previous studies, individuals make saving and labor supply decisions simultaneously. We use a two period model in which both saving and labor supply are distinct sources of present disutility and alternative sources of future in-come, consider the case in which tax-base uncertainty increases expected tax revenues, and find that the government may be able to charge the tax rate so that the welfare of a representative, risk-averse consumer increases, in spite of the presence of greater tax-base risk. Our analysis reveals that a set of assumption about attitudes towards risk that is sufficient to conclude that the introduction of randomization of the tax base increases economic well-being.