Optimal Policy and (the Lack of) Time Inconsistency: Insights from Simple Models
In the standard neoclassical model with a representative agent, a benevolent planner who can commit to future policies will, if feasible, levy a single confiscatory tax on capital in the initial period and commit never to set positive taxes thereafter. We show that this policy, which allows for the disposal of distortional taxes entirely, can arise even when sequential governments are unable to credibly promise future tax rates, regardless of how public expenditures are determined.
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