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Optimal fiscal policy with recursive preferences

  • Karantounias, Anastasios G.

    ()

    (Federal Reserve Bank of Atlanta)

I study optimal capital and labor income taxation in a business cycle model with the recursive preferences of Epstein and Zin (1989) and Weil (1990). In contrast to the case of time-additive expected utility, I find that it is no longer optimal to make the welfare cost of distortionary taxes constant over states and dates. This dramatically alters standard taxation prescriptions: optimal policy calls for taxation at the intertemporal margin, variation of taxation at the intratemporal margin, and persistence of labor taxes independent of the stochastic properties of exogenous shocks. Ignoring the distinction between smoothing over time and smoothing over states is not an innocuous assumption for optimal policy.

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File URL: http://www.frbatlanta.org/documents/pubs/wp/wp1307.pdf
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Paper provided by Federal Reserve Bank of Atlanta in its series Working Paper with number 2013-07.

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Length: 47 pages
Date of creation: 01 Sep 2013
Date of revision:
Handle: RePEc:fip:fedawp:2013-07
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  8. Karantounias, Anastasios G., 2013. "Managing pessimistic expectations and fiscal policy," Theoretical Economics, Econometric Society, vol. 8(1), January.
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  13. Weil, Philippe, 1990. "Nonexpected Utility in Macroeconomics," The Quarterly Journal of Economics, MIT Press, vol. 105(1), pages 29-42, February.
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  15. Emmanuel Farhi, 2010. "Capital Taxation and Ownership When Markets Are Incomplete," Journal of Political Economy, University of Chicago Press, vol. 118(5), pages 908 - 948.
  16. Kreps, David M & Porteus, Evan L, 1978. "Temporal Resolution of Uncertainty and Dynamic Choice Theory," Econometrica, Econometric Society, vol. 46(1), pages 185-200, January.
  17. Tomasz Strzalecki, 2011. "Axiomatic Foundations of Multiplier Preferences," Levine's Working Paper Archive 786969000000000126, David K. Levine.
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  19. Geoffard, Pierre-Yves, 1996. "Discounting and Optimizing: Capital Accumulation Problems as Variational Minmax Problems," Journal of Economic Theory, Elsevier, vol. 69(1), pages 53-70, April.
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