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Optimal Taxation in a Limited Commitment Economy

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  • Yena Park

    (Department of Economics, University of Pennsylvania)

Abstract

This paper studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labor because individuals do not take into account that their labor and saving decisions affect aggregate supply, wages and thus the value of autarky. Due to these externalities, the Ramsey government has an additional goal, which is to internalize the externalities of labor and capital to improve risk sharing, in addition to its usual goal - minimizing distortions when financing government expenditures. These two goals drive capital and labor taxes in opposite directions. By balancing these conflicting goals, the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, and optimal labor income taxes are set to meet the budgetary needs of the government in the long run, despite positive externalities of labor.

Suggested Citation

  • Yena Park, 2012. "Optimal Taxation in a Limited Commitment Economy," PIER Working Paper Archive 12-033, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.
    • Handle: RePEc:pen:papers:12-033
    as

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    File URL: https://economics.sas.upenn.edu/sites/default/files/filevault/12-033.pdf
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Optimal Taxation in a Limited Commitment Economy
      by Christian Zimmermann in NEP-DGE blog on 2012-09-11 21:52:10

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    More about this item

    Keywords

    Ramsey Taxation; Limited Enforcement;

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies

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