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Optimal Taxation without State-Contingent Debt

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Listed:
  • S. Rao Aiyagari
  • Albert Marcet
  • Thomas J. Sargent
  • Juha Seppala

Abstract

In an economy studied by Lucas and Stokey, tax rates inherit the serial correlation structure of government expenditures, belying Barro's earlier result that taxes should be a random walk for any stochastic process of government expenditures. To recover a version of Barro's random walk tax-smoothing outcome, we modify Lucas and Stokey's economy to permit only risk-free debt. Having only risk-free debt confronts the Ramsey planner with additional constraints on equilibrium allocations beyond one imposed by Lucas and Stokey's assumption of complete markets. The Ramsey outcome blends features of Barro's model with Lucas and Stokey's. In our model, the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in Lucas and Stokey's model, but incomplete markets put a nearunit root component into government debt and taxes, an outcome like Barro's. However, we show that without ad hoc limits on the government's asset holdings, outcomes can diverge in important ways from Barro's. Our results use and extend recent advances in the consumption-smoothing literature.

Suggested Citation

  • S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  • Handle: RePEc:ucp:jpolec:v:110:y:2002:i:6:p:1220-1254
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    References listed on IDEAS

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E17 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Forecasting and Simulation: Models and Applications

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    1. Recursive Macroeconomic Theory

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