The Optimum Quantity of Capital and Debt

Marcus Hagedorn, Acikgöz, Ömer, Hans Holter and Yikai Wang

No 12952, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: In this paper we solve the dynamic optimal Ramsey taxation problem in a model with incomplete markets, where the government commits itself ex-ante to a time path of labor taxes, capital taxes and debt to maximize the discounted sum of agents' utility starting from today. Whereas the literature has been limited mainly to studying policies that maximize steady-state welfare only, we instead characterize the optimal policy along the full transition path. We show theoretically that in the long run the capital stock satisfies the modified golden rule. We also prove that in contrast to complete markets economies, in incomplete markets economies the long run steady-state resulting from an infinite sequence of optimal policy choices is independent of initial conditions. This result is not only of theoretical interest but moreover enables computing the long-run optimum independently from the transition path, rendering a quantitative analysis tractable. Quantitatively we find, robustly across various calibrations, that in the long run the government debt-to-GDP ratio is high, capital is taxed at a low rate and labor income at a high rate when compared to current U.S. values. Along the optimal transition to the steady state, labor taxes initially are lowered, financed through issuing more debt and taxing capital income heavily, before they are eventually increased to their steady-state level.

Keywords: Optimal government debt; Incomplete markets; Capital taxation; Dynamically optimal taxation (search for similar items in EconPapers)
JEL-codes: E62 H20 H60 (search for similar items in EconPapers)
Date: 2018-05
New Economics Papers: this item is included in nep-dge, nep-gro, nep-mac, nep-pbe and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (22)

Downloads: (external link)
https://cepr.org/publications/DP12952 (application/pdf)
CEPR Discussion Papers are free to download for our researchers, subscribers and members. If you fall into one of these categories but have trouble downloading our papers, please contact us at subscribers@cepr.org

Related works:
Working Paper: The Optimum Quantity of Capital and Debt (2015)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:cpr:ceprdp:12952

Ordering information: This working paper can be ordered from
https://cepr.org/publications/DP12952

Access Statistics for this paper

More papers in CEPR Discussion Papers from C.E.P.R. Discussion Papers Centre for Economic Policy Research, 33 Great Sutton Street, London EC1V 0DX.
Bibliographic data for series maintained by ().