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Optimal Ramsey Capital Income Taxation —A Reappraisal

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Abstract

This paper addresses a long-standing problem in the optimal Ramsey capital taxation literature. The tractability of our model enables us to solve the Ramsey problem analytically along the entire transitional path. We show that the conventional wisdom on Ramsey tax policy and its underlying intuition and rationales do not hold in our model and may thus be misrepresented in the literature. We uncover a critical trade off for the Ramsey planner between aggregate allocative efficiency in terms of the modified golden rule and individual allocative efficiency in terms of self-insurance. Facing the trade-off, the Ramsey planner prefers issuing debt rather than taxing capital if possible. In particular, the planner always intends to supply enough bonds to relax individuals'' borrowing constraints to achieve the modified golden rule by crowding out capital. A capital tax is not the optimal tool to achieve aggregate allocative efficiency, despite possible over-accumulation of capital. Thus, the optimal capital tax can be zero, positive, or even negative, depending on the Ramsey planner's ability to issue debt. The modified golden rule can fail to hold whenever the government encounters a debt limit. Finally, the planner's desire to relax individuals'' borrowing constraints may lead to unlimited debt accumulation, resulting in a dynamic path featuring no steady state.

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  • YiLi Chien & Yi Wen, 2017. "Optimal Ramsey Capital Income Taxation —A Reappraisal," Working Papers 2017-24, Federal Reserve Bank of St. Louis.
  • Handle: RePEc:fip:fedlwp:2017-024
    DOI: 10.20955/wp.2017.024
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    File URL: https://doi.org/10.20955/wp.2017.024
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    References listed on IDEAS

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    1. Gabriele Camera & Yili Chien, 2014. "Understanding the Distributional Impact of Long‐Run Inflation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 46(6), pages 1137-1170, September.
    2. Julio Dávila & Jay H. Hong & Per Krusell & José‐Víctor Ríos‐Rull, 2012. "Constrained Efficiency in the Neoclassical Growth Model With Uninsurable Idiosyncratic Shocks," Econometrica, Econometric Society, vol. 80(6), pages 2431-2467, November.
    3. Timothy J. Kehoe & David K. Levine, 1993. "Debt-Constrained Asset Markets," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 865-888.
    4. Ljungqvist, Lars & Sargent, Thomas J., 2012. "Recursive Macroeconomic Theory, Third Edition," MIT Press Books, The MIT Press, edition 3, volume 1, number 0262018748, September.
    5. Acikgoz, Omer, 2013. "Transitional Dynamics and Long-run Optimal Taxation Under Incomplete Markets," MPRA Paper 50160, University Library of Munich, Germany.
    6. Sebastian Dyrda & Marcelo Pedroni, 2015. "Optimal Fiscal Policy in a Model with Uninsurable Idiosyncratic Shocks," Working Papers tecipa-549, University of Toronto, Department of Economics.
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    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Ramsey Capital Income Taxation —A Reappraisal
      by Christian Zimmermann in NEP-DGE blog on 2017-09-21 20:29:43

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    Cited by:

    1. YiLi Chien & Yi Wen, 2019. "Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences," Working Papers 2019-007, Federal Reserve Bank of St. Louis, revised 18 May 2020.
    2. Krueger, Dirk & Ludwig, Alexander, 2018. "Optimal Taxes on Capital in the OLG Model with Uninsurable Idiosyncratic Income Risk," MEA discussion paper series 201802, Munich Center for the Economics of Aging (MEA) at the Max Planck Institute for Social Law and Social Policy.
    3. Dong, Feng & Wen, Yi, 2019. "Long and Plosser meet Bewley and Lucas," Journal of Monetary Economics, Elsevier, vol. 102(C), pages 70-92.
    4. Yunmin Chen & YiLi Chien & C.C. Yang, 2017. "Implementing the Modified Golden Rule? Optimal Ramsey Capital Taxation with Incomplete Markets Revisited," Working Papers 2017-003, Federal Reserve Bank of St. Louis, revised 01 Oct 2020.
    5. Feng Dong & Yi Wen, 2019. "Time-Varying Networks and the Efficacy of Money Without Sticky Prices," 2019 Meeting Papers 1464, Society for Economic Dynamics.

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    More about this item

    Keywords

    Optimal Capital Taxation; Ramsey Problem; Incomplete Market;
    All these keywords.

    JEL classification:

    • E13 - Macroeconomics and Monetary Economics - - General Aggregative Models - - - Neoclassical
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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