Applying perturbation analysis to dynamic optimal tax problems

Charles Brendon

No 581, Economics Series Working Papers from University of Oxford, Department of Economics

Abstract: This paper shows how to derive a complete set of optimality conditions characterising the solution to a dynamic optimal income tax problem in the spirit of Mirrlees (1971), under the assumption that a 'first-order' approach to incentive compatibility is valid. The method relies on constructing perturbations to the consumption-output allocations of agents in a manner that preserves incentive compatibility for movements in both directions along the specified dimension. We are able to use it to generalise the 'inverse Euler condition' to cases in which preferences are non-separable between consumption and labour supply, and to prove a number of novel results about optimal income and savings tax wedges.

Keywords: New Dynamic Public Finance; First-order approach; Non-separable preferences; Inverse Euler condition (search for similar items in EconPapers)
JEL-codes: D82 E61 H21 H24 (search for similar items in EconPapers)
Date: 2011-11-01
New Economics Papers: this item is included in nep-dge and nep-pub
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