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Applying perturbation analysis to dynamic optimal tax problems

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  • Charles Brendon

Abstract

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.

Suggested Citation

  • Charles Brendon, 2011. "Applying perturbation analysis to dynamic optimal tax problems," Economics Series Working Papers 581, University of Oxford, Department of Economics.
    • Handle: RePEc:oxf:wpaper:581
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    References listed on IDEAS

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    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(s1), pages 147-174, August.
    7. Mikhail Golosov & Narayana Kocherlakota & Aleh Tsyvinski, 2003. "Optimal Indirect and Capital Taxation," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 70(3), pages 569-587.
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    9. 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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    More about this item

    Keywords

    New Dynamic Public Finance; First-order approach; Non-separable preferences; Inverse Euler condition;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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