Taxation without Commitment

Reis, Catarina (2006): Taxation without Commitment. Unpublished.

Abstract

This paper considers a Ramsey model of linear capital and labor income taxation in which a benevolent government cannot commit ex-ante to a sequence of taxes for the future. In this setup, if the government is allowed to borrow and lend to the consumers, the optimal capital income tax is zero in the long run. This result stands in marked contrast with the recent literature on optimal taxation without commitment, which imposes budget balance and typically finds that the optimal capital income tax does not converge to zero. Since it is efficient to backload incentives, breaking budget balance allows the government to generate surplus that reduces its debt or increases its assets over time until the lack of commitment is no longer binding and the economy is back in the full commitment solution. Therefore, while the lack of commitment does not change the optimal capital tax in the long run, it may impose an upper bound on the level of long run debt.

• Item Type: MPRA Paper
• Institution: MIT
• Language: English
• Keywords: Fiscal Policy; Optimal Taxation; Incidence; Debt
• Subjects: H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H22 - Incidence; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy Formation, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E62 - Fiscal Policy; Public Expenditures, Investment, and Finance; Taxation; H - Public Economics > H6 - National Budget, Deficit, and Debt > H62 - Deficit; Surplus; H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency; Optimal Taxation