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Markov-Perfect Optimal Taxation

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  • Salvador Ortigueira

    (European University Institute)

Abstract

In this paper we study optimal taxation in a dynamic game played by a sequence of governments and a private sector composed of a continuum of households. We focus on the Markov-perfect equilibrium of this game under two different assumptions on the extent of government's intra-period commitment, which in turn define two notions of time consistency of the Markov policy. Our results show that the extent of government's intra-period commitment has important quantitative implications for policies, welfare, and macroeconomic variables, and consequently that it must be explicitly stated as one of the givens of the economy, alongside preferences, markets and technology. We see this as an important result, since most of the previous literature on Markovian optimal taxation has assumed, either interchangeably or unnoticeably, different degrees of government's intra-period commitment. (Copyright: Elsevier)

Suggested Citation

  • Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
  • Handle: RePEc:red:issued:v:9:y:2006:i:1:p:153-178
    DOI: 10.1016/j.red.2005.10.001
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    References listed on IDEAS

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    1. Per Krusell & Anthony A. Smith, Jr., 2003. "Consumption--Savings Decisions with Quasi--Geometric Discounting," Econometrica, Econometric Society, vol. 71(1), pages 365-375, January.
    2. Gerhard Sorger, 1997. "Markov-perfect Nash equilibria in a class of resource games," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 11(1), pages 79-100.
    3. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
    4. Maskin, Eric & Tirole, Jean, 2001. "Markov Perfect Equilibrium: I. Observable Actions," Journal of Economic Theory, Elsevier, vol. 100(2), pages 191-219, October.
    5. Daniel Cohen & Philippe Michel, 1988. "How Should Control Theory Be Used to Calculate a Time-Consistent Government Policy?," Review of Economic Studies, Oxford University Press, vol. 55(2), pages 263-274.
    6. Dmitry V. Vedenov & Mario J. Miranda, 2001. "Numerical solution of dynamic oligopoly games with capital investment," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 18(1), pages 237-261.
    7. Turnovsky, Stephen J. & Brock, William A., 1980. "Time consistency and optimal government policies in perfect foresight equilibrium," Journal of Public Economics, Elsevier, vol. 13(2), pages 183-212, April.
    8. Paul Klein & Per Krusell & José-Víctor Ríos-Rull, 2004. "Time-Consistent Public Expenditures," Levine's Bibliography 122247000000000652, UCLA Department of Economics.
    9. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
    10. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-491, June.
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    More about this item

    Keywords

    Markov-perfect optimal taxation; Time-consistent policies; Instantaneous and non-instantaneous commitment; Numerical methods;

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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