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Optimal Fiscal Policy with Redistribution

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  • Iván Werning

Abstract

I study the optimal taxation oflabor and capital in a dynamic economy subject to government expenditure and technology shocks. Unlike representative-agent Ramsey models, workers are heterogenous and lump-sum taxation is not ruled out. I consider two tax scenarios: (a) linear taxation, with a lump-sum intercept and (b) nonlinear-Mirrleesian taxation. When taxes are linear, I derive a partial-equivalence result with Ramsey settings that provides a reinterpretation of such analyses. I find conditions for perfect tax smoothing oflabor-income taxes and zero capital taxation. Implications that contrast with Ramsey are derived for public-debt management, for the nature of the time-inconsistency problem and for the viability of replicating complete markets without state-contingent bonds. Shifts in the distribution of skills provide a novel source for variations in tax rates. For the nonlinear tax scenario, I show that taxation based on income averages is optimal.

Suggested Citation

  • Iván Werning, 2007. "Optimal Fiscal Policy with Redistribution," The Quarterly Journal of Economics, Oxford University Press, vol. 122(3), pages 925-967.
  • Handle: RePEc:oup:qjecon:v:122:y:2007:i:3:p:925-967.
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    File URL: http://hdl.handle.net/10.1162/qjec.122.3.925
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