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On the Optimal Tax Schedule

Listed author(s):
  • Radim Bohacek
  • Michal Kejak

In this paper we develop a new general methodology for computing the optimal, welfare maximizing social planner's policies for economies with heterogeneous agents in which the stationary distribution of agents is a part of the optimization problem. Previous models analyzing the effects of government policies in this class of models were limited to sub-optimal policy reforms exogenously imposed on the model. Our approach does not use any additional restrictions or assumptions on the equilibrium allocations but is strictly derived from the first order and envelope conditions, and from the stationarity of the endogenous distribution of agents in the steady state. In other words, we solve simultaneously for the optimal individual allocations, for the optimal policy function, and for the distribution of agents. The methodology provides for a general solution method applicable to a wide range of optimal government policies in models with heterogeneous agents. We illustrate the methodology by solving for a Ramsey problem with distortionary taxation of total income from labor and capital incomes. The optimal tax schedule takes simultaneously into account its impact on the endogenous distribution of agents over assets in the steady state and the resulting welfare consequences.

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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 714.

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Date of creation: 2004
Handle: RePEc:red:sed004:714
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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