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Applying perturbation analysis to dynamic optimal tax problems

  • Charles Brendon
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    This paper shows how to derive a complete set of optimality conditions characterising the solution to a dynamic optimal income tax problem in the spirit of Mirrlees (1971), under the assumption that a 'first-order' approach to incentive compatibility is valid. The method relies on constructing perturbations to the consumption-output allocations of agents in a manner that preserves incentive compatibility for movements in both directions along the specified dimension. We are able to use it to generalise the 'inverse Euler condition' to cases in which preferences are non-separable between consumption and labour supply, and to prove a number of novel results about optimal income and savings tax wedges.

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    File URL: http://www.economics.ox.ac.uk/materials/working_papers/paper581.pdf
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    Paper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number 581.

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    Date of creation: 01 Nov 2011
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    Handle: RePEc:oxf:wpaper:581
    Contact details of provider: Postal: Manor Rd. Building, Oxford, OX1 3UQ
    Web page: http://www.economics.ox.ac.uk/
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    1. Matthias Messner & Nicola Pavoni & Christopher Sleet, 2011. "Recursive methods for incentive problems," Working Papers 381, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    2. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," Review of Economic Studies, Wiley Blackwell, vol. 70(3), pages 569-587, 07.
    3. N. Gregory Mankiw & Matthew Weinzierl & Danny Yagan, 2009. "Optimal Taxation in Theory and Practice," NBER Working Papers 15071, National Bureau of Economic Research, Inc.
    4. Emmanuel Farhi & Iván Werning, 2007. "Inequality and Social Discounting," Journal of Political Economy, University of Chicago Press, vol. 115, pages 365-402.
    5. Mele, Antonio, 2011. "Repeated moral hazard and recursive Lagrangeans," MPRA Paper 30310, University Library of Munich, Germany.
    6. Mikhail Golosov & Maxim Troshkin & Aleh Tsyvinski, 2011. "Optimal Taxation: Merging Micro and Macro Approaches," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 43, pages 147-174, 08.
    7. Mikhail Golosov & Aleh Tsyvinski & Ivan Werning, 2007. "New Dynamic Public Finance: A User's Guide," NBER Chapters, in: NBER Macroeconomics Annual 2006, Volume 21, pages 317-388 National Bureau of Economic Research, Inc.
    8. Fernandes, Ana & Phelan, Christopher, 2000. "A Recursive Formulation for Repeated Agency with History Dependence," Journal of Economic Theory, Elsevier, vol. 91(2), pages 223-247, April.
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