Optimal Dynamic Tax-Transfer Policies in Heterogeneous-Agents Economies

YiLi Chien and Yi Wen

No 2023-009, Working Papers from Federal Reserve Bank of St. Louis

Abstract: When designing an optimal tax-transfer system, the existing literature identifies two key factors: labor efficiency and debt efficiency. The labor-efficiency approach emphasizes the trade-off between redistribution and distortion in the labor market, while the debt-efficiency approach emphasizes the trade-off between monopoly rent gains and distortion in the asset market. In this paper, we propose a third factor for designing optimal tax-transfer policies: the dynamic-efficiency approach. To demonstrate this, we use an analytically tractable infinite-horizon model incorporating both ex-ante and ex-post heterogeneity. We show that the optimal tax-transfer system is determined at the point where the intertemporal wedge between the market interest rate and the time discount rate is completely eliminated, regardless of the Laffer curve, provided that the government’s fiscal space permits an interior Ramsey steady state. Therefore, in line with recent findings by Chien and Wen (2024), incorporating dynamic efficiency could potentially transform the structure of optimal tax-transfer policies within an infinite-horizon model featuring heterogeneous agents.

Keywords: Ramsey redistribution; optimal tax-transfer system; optimal interest rate; Laffer curve; incomplete markets; heterogeneity (search for similar items in EconPapers)
JEL-codes: E13 E62 H21 H30 (search for similar items in EconPapers)
Pages: 48 pages
Date: 2023-05-01, Revised 2025-06-27
New Economics Papers: this item is included in nep-dge, nep-pbe and nep-pub
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DOI: 10.20955/wp.2023.009

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