Optimal Taxation in a Limited Commitment Economy

Yena Park ()
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Yena Park: Department of Economics, University of Pennsylvania

PIER Working Paper Archive from Penn Institute for Economic Research, Department of Economics, University of Pennsylvania

Abstract: This paper studies optimal Ramsey taxation when risk sharing in private insurance markets is imperfect due to limited enforcement. In a limited commitment economy, there are externalities associated with capital and labor because individuals do not take into account that their labor and saving decisions affect aggregate supply, wages and thus the value of autarky. Due to these externalities, the Ramsey government has an additional goal, which is to internalize the externalities of labor and capital to improve risk sharing, in addition to its usual goal - minimizing distortions when financing government expenditures. These two goals drive capital and labor taxes in opposite directions. By balancing these conflicting goals, the steady-state optimal capital income taxes are levied only to remove the negative externality of the capital, and optimal labor income taxes are set to meet the budgetary needs of the government in the long run, despite positive externalities of labor.

Keywords: Ramsey Taxation; Limited Enforcement (search for similar items in EconPapers)
JEL-codes: D52 E62 H21 H23 (search for similar items in EconPapers)
Pages: 51 pages
Date: 2012-08-28
New Economics Papers: this item is included in nep-dge and nep-pub
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