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Taxation without commitment

  • Catarina Reis


This paper considers a Ramsey model of linear capital and labor income taxation in which a benevolent government cannot commit ex-ante to a sequence of policies for the future. In this setup, if the government is forced to keep budget balance in every period, then it may not be able to sustain zero capital taxes in the long run, as shown in Benhabib and Rustichini (J Econ Theory 77:231–259, 1997 ) and Phelan and Stachetti (Econometrica 69:1491–1518, 2001 ). However, (Dominguez in J Econ Theory 135:159–170, 2007 ) shows that if the government is allowed to borrow and lend to households, the optimal capital income tax still converges to zero in the long run, as long as the value of defaulting is independent of the level of government debt. This paper provides a game theoretic setup with government debt where the value of the worst equilibrium only depends on the initial level of capital and can be determined in advance. This implies that under our assumptions the best sustainable equilibrium has zero capital taxes in the long run, even in the absence of government commitment. Copyright Springer-Verlag 2013

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Article provided by Springer in its journal Economic Theory.

Volume (Year): 52 (2013)
Issue (Month): 2 (March)
Pages: 565-588

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Handle: RePEc:spr:joecth:v:52:y:2013:i:2:p:565-588
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  1. Daron Acemoglu & Michael Golosov & Aleh Tsyvinski, 2006. "Markets Versus Governments: Political Economy of Mechanisms," Levine's Bibliography 321307000000000032, UCLA Department of Economics.
  2. Benveniste, L M & Scheinkman, J A, 1979. "On the Differentiability of the Value Function in Dynamic Models of Economics," Econometrica, Econometric Society, vol. 47(3), pages 727-32, May.
  3. GOBERT, Karine & POITEVIN, Michel, 1998. "Non-Commitment and Savings in Dynamic Risk-Sharing Contracts," Cahiers de recherche 9806, Universite de Montreal, Departement de sciences economiques.
  4. Mark Aguiar & Manuel Amador & Gita Gopinath, 2006. "Efficient expropriation: sustainable fiscal policy in a small open economy," Working Papers 06-9, Federal Reserve Bank of Boston.
  5. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans," Staff Report 122, Federal Reserve Bank of Minneapolis.
  6. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  7. V. V. Chari & Patrick E. Kehoe, 1990. "Sustainable Plans and Mutual Default," IMF Working Papers 90/22, International Monetary Fund.
  8. Albert Marcet & Ramon Marimon, 1991. "Communication, commitment and growth," Economics Working Papers 1, Department of Economics and Business, Universitat Pompeu Fabra.
  9. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
  10. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  11. Klein, Paul & Krusell, Per & Ríos-Rull, José-Víctor, 2004. "Time Consistent Public Expenditures," CEPR Discussion Papers 4582, C.E.P.R. Discussion Papers.
  12. V. V. Chari & Patrick J. Kehoe, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Oxford University Press, vol. 60(1), pages 175-195.
  13. 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 473-91, June.
  14. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 595-609.
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  17. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  18. Benhabib, J. & Rustichini, A., 1996. "Optimal Taxes Without Commitment," Working Papers 96-18, C.V. Starr Center for Applied Economics, New York University.
  19. Christopher Phelan & Ennio Stacchetti, 2001. "Sequential Equilibria in a Ramsey Tax Model," Econometrica, Econometric Society, vol. 69(6), pages 1491-1518, November.
  20. V. V. Chari & Patrick J. Kehoe, 1993. "Sustainable Plans and Mutual Default," Review of Economic Studies, Oxford University Press, vol. 60(1), pages 175-195.
  21. Debraj Ray, 2002. "The Time Structure of Self-Enforcing Agreements," Econometrica, Econometric Society, vol. 70(2), pages 547-582, March.
  22. Jorge Soares, Marina Azzimonti, Pierre-Daniel Sarte & Pierre-Daniel Sarte & Jorge Soares, 2006. "Optimal Policy and (the Lack of) Time Inconsistency: Insights from Simple Models," Working Papers 06-08, University of Delaware, Department of Economics.
  23. V. V. Chari & Patrick J. Kehoe, 1989. "Sustainable plans and debt," Staff Report 125, Federal Reserve Bank of Minneapolis.
  24. Albert Marcet & Thomas J. Sargent & Juha Seppala, 1996. "Optimal taxation without state-contingent debt," Economics Working Papers 170, Department of Economics and Business, Universitat Pompeu Fabra, revised Oct 2001.
  25. Abreu, Dilip, 1988. "On the Theory of Infinitely Repeated Games with Discounting," Econometrica, Econometric Society, vol. 56(2), pages 383-96, March.
  26. Narayana R. Kocherlakota, 1996. "Implications of Efficient Risk Sharing without Commitment," Review of Economic Studies, Oxford University Press, vol. 63(4), pages 595-609.
  27. Jorge Soares & Marina Azzimonti & Pierre-Daniel Sarte, 2005. "Optimal Fiscal Policy and the (Lack of) Time Inconsistency Problem," 2005 Meeting Papers 481, Society for Economic Dynamics.
  28. Klein Paul & Quadrini Vincenzo & Rios-Rull Jose-Victor, 2005. "Optimal Time-Consistent Taxation with International Mobility Of Capital," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-36, June.
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