Optimal Taxation with Endogenous Insurance Markets

Mikhail Golosov and Aleh Tsyvinski

No 11185, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We study optimal tax policy in a dynamic private information economy with endogenous private markets. We characterize efficient allocations and competitive equilibria. A standard assumption in the literature is that trades are observable by all agents. We show that in such an environment the competitive equilibrium is efficient. The only effect of government interventions is crowding out of private insurance. We then relax the assumption of observability of consumption and consider an environment with unobservable trades in competitive markets. We show that efficient allocations have the property that the marginal product of capital is different from the market interest rate associated with unobservable trades. In any competitive equilibrium without taxation, the marginal product of capital and the market interest rate are equated, so that competitive equilibria are not efficient. Taxation of capital income can be welfare-improving because such taxation introduces a wedge between market interest rates and the marginal product of capital and allows agents to obtain better insurance in private markets. Finally, we use plausibly calibrated numerical examples to compute optimal taxes and welfare gains and compare results to an economy with a restricted set of tax instruments, and to an economy with observable trades.

JEL-codes: E62 H21 H23 H53 (search for similar items in EconPapers)
Date: 2005-03
New Economics Papers: this item is included in nep-dge, nep-ias, nep-mac, nep-pbe and nep-pub
Note: EFG PE
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (35)

Published as Mikhail Golosov, 2007. "Optimal Taxation With Endogenous Insurance Markets," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 487-534, 05.

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Journal Article: Optimal Taxation with Endogenous Insurance Markets (2007)
Working Paper: Optimal Taxation with Endogenous Insurance Markets (2006)
Working Paper: Optimal Taxation with Endogenous Insurance Markets (2004)
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