Taxes, Wedges and Aggregate Uncertainty: A Mirrleesian Approach

We study optimal taxation in a dynamic Mirrlees' incentive structure where both aggregate and idiosyncratic risks are present. When aggregate shocks are i.i.d., we characterize the steady-state of our economy and prove the existence of an invariant distribution of expected utilities, which is non-degenerate thanks to the perpetual youth we assume. We show that consumption and income shares of each cohort are invariant to the aggregate state. In contrast, when aggregate shocks are persistent, efficient allocations display history dependence, and no invariant distribution needs to exist. We provide a particular example in which it does not exist and one in which it does. In the latter case, the particular distribution at which a society settles depends on the whole history of aggregate shocks.