Optimal Taxation and Constrained Inefficiency in an Infinite-Horizon Economy with Incomplete Markets
Title: Optimal Taxation and Constrained Inefficiency in an Infinite-Horizon Economy with Incomplete Markets
Series/Report no.: EUI ECO; 2011/18
We study the dynamic Ramsey problem of finding optimal public debt and linear taxes on capital and labor income within a tractable infinite horizon model with incomplete markets. With zero public expenditure and debt, it is optimal to tax the risky labor income and subsidize capital, while a positive amount of public debt is welfare improving. A steady state optimality condition is derived which implies that the tax on capital is positive, when savings are sufficiently inelastic to returns. A calibration of our model to the US economy indicates positive optimal taxes and a small but positive optimal debt level.
Subject: incomplete markets; Ramsey equilibrium; optimal taxation; optimal public debt; constrained inefficiency; D52; D60; D90; E20; E62; H21; O40
Type of Access: openAccess