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Optimal taxation in life-cycle economies

  • Andres Erosa
  • Martin Gervais

We use a very standard life-cycle growth model, in which individuals have a labor-leisure choice in each period of their lives, to prove that an optimizing government will almost always find it optimal to tax or subsidize interest income. The intuition for our result is straightforward. In a life-cycle model the individual’s optimal consumption-work plan is almost never constant and an optimizing government almost always taxes consumption goods and labor earnings at different rates over an individual’s lifetime. One way to achieve this goal is to use capital and labor income taxes that vary with age. If tax rates cannot be conditioned on age, a non-zero tax on capital income is also optimal, as it can (imperfectly) mimic age-conditioned consumption and labor income tax rates.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 00-02.

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Date of creation: 2000
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Handle: RePEc:fip:fedrwp:00-02
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  16. Finis Welch, 1979. "Effects of Cohort Size on Earnings: The Baby Boom Babies' Financial Bust," UCLA Economics Working Papers 146, UCLA Department of Economics.
  17. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November.
  18. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  19. Yvette Alvarez & John Burbidge & Ted Farrell & Leigh Palmer, 1992. "Optimal Taxation in a Life-Cycle Model," Canadian Journal of Economics, Canadian Economics Association, vol. 25(1), pages 111-22, February.
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