The Inconsistency Puzzle Resolved: an Omitted Variable

Nikolay Arefiev ()

No EERI_RP_2008_15, EERI Research Paper Series from Economics and Econometrics Research Institute (EERI)

Abstract: The contemporary version of the dynamic Ramsey problem omits expectations of a household’s initial lump-sum wealth taxation due to policy revision; therefore, the attainable resource allocation set in this problem is ill-defined. This omission leads to misleading conclusions about the optimal policy in the short run and, in particular, that the Ramsey policy is dynamically inconsistent. The effect of introducing the expectations into the analysis of dynamic inconsistency is similar to that of introducing expected inflation into the Phillips curve: we show that only an unexpected policy surprise affects the attainable resource allocation set and the optimal policy. In contrast to Chamley (1986), we show that intensive capital income taxation at the beginning of an optimal policy does not imply a lump-sum taxation of household wealth and cannot reduce the excess tax burden. We also demonstrate that the Ramsey policy is dynamically consistent even without commitment. We resolve the Ramsey problem and compare our results to those of Chamley on optimal capital income taxation.

Keywords: Consistency; Equilibrium policy; Optimal taxation (search for similar items in EconPapers)
JEL-codes: E61 E62 H21 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge and nep-mac
Date: 2008-10-26
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Working Paper: The Inconsistency Puzzle Resolved: an Omitted Variable (2008)
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