On the Time Inconsistency of Optimal Monetary and Fiscal Policies with Many Consumer Goods*

In this paper, we study the time consistency of optimal policies in an environment where agents use cash to purchase many consumer goods and where those goods might be taxed at differential rates. Our main result is that optimal monetary and fiscal policies are, in general, time‐inconsistent, because the number of bond instruments is insufficient to influence all future fiscal decisions. However, there is one special case where optimal policies are time‐consistent, which is when differential tax rates across cash goods are optimally zero.     

Expenditure taxes,income taxes,and time-inconsistency

Traditional welfare-based comparisons of different tax structures implicitly assume that the government can precommit to its future optimal policy. When optimal tax rates are time- inconsistent, however, such comparisons may be misleading. This paper uses a two-period representative-consumer optimal taxation model to study the implications of time-consistency for the welfare rankings of expenditure and income taxation. I show that the welfare rankings of optimal policies may not be preserved by time-consistent ones.     

Optimal Taxation in Life-Cycle Economies

We use a very standard life-cycle growth model, in which individuals have a labor-leisure choice in each period of their lives, to prove that an optimizing government will almost always find it optimal to tax or subsidize interest income. The intuition for our result is straightforward. In a life-cycle model the individual's optimal consumption-work plan is almost never constant and an optimizing government almost always taxes consumption goods and labor earnings at different rates over an individual's lifetime. One way to achieve this goal is to use capital and labor income taxes that vary with age. If tax rates cannot be conditioned on age, a nonzero tax on capital income is also optimal, as it can (imperfectly) mimic age-conditioned consumption and labor income tax rates. Journal of Economic Literature Classification Numbers: E62, H21.     

Numerical simulation on property tax reform: evidence from China

This article analyses the property tax reform in China in a computable general equilibrium model that recognizes the interaction between and among housing markets in different provinces and macroeconomic development. Using real data in 2010, we present the benchmark equilibrium for reference property and income tax rates. Then, we examine different property and income tax policies and make a comparison of their production, consumption, welfare and national income. We find that the implementation of property tax would decrease the house production at the expense of welfare in taxed area. The expansion of the taxed regions may increase the total social welfare and national income. Even though property tax policy may not be able to change the income distribution in China, increasing income tax rate could narrow the income disparity. Finally, this article shows the reliability of the conclusions when sensitivity analysis on optimal condition of equilibrium computation is performed under varied property tax policy.     

Optimal mixed taxation,credit constraints,and the timing of income tax reporting

We study optimal income and commodity tax policy with credit‐constrained low‐income households. Workers receive an even flow of income during the tax year, but report their incomes and make tax payments (receive transfers) at the end of the year. They spend their disposable income on multiple commodities over the year. We show that differentiated subsidies on commodities can be optimal even if the Atkinson–Stiglitz Theorem conditions apply. When the optimal policy leaves low‐income households with binding credit constraints, it may be optimal to subsidize differentially the good that they consume in higher proportion. Uniform subsidies would also relax the credit constraint, but would be more costly to the government since they would equally benefit unconstrained households. Numerical examples suggest that commodity tax differentiation increases with basic needs and with the interest rate at which government borrows.     

Capital income taxation,tax criteria,and intergenerational welfare

In a two-period overlapping-generations model, residence criteria are shown to be optimal with lump-sum transfers to the younger generation in a dynamically efficient open economy even if all wage income, corresponding to rent income under exogenous labor supply, is not taxed away. When tax revenues are also distributed to the older generation — which indeed may be desirable for short-term intergenerational welfare distribution reasons — a weighted average rule is derived for optimal international taxation. The taxation of domestic savings income follows the inverse elasticity rule in respect to savings and, surprisingly, higher investment elasticity increases the tax level. Finally, for a small open economy and for large identical economies, tax competition with a mixed scheme of residence-based taxes and source-based subsidies yields the same tax policy as tax cooperation with no restrictions on the domestic and international capital income tax instruments.     

Optimal Design of Forest Taxation with Multiple-Use Characteristics of Forest Stands

The paper studies optimal forest taxation under uncertainty about future timber price when private forest owners value amenity services of forest stands and forest stands have public goods characteristics. It is assumed that preferences of forest owners can be described by a quasi-linear, intertemporal utility function which reflects risk aversion in terms of consumption and constant marginal utility in terms of amenity services. The comparative statics of current and future harvesting in terms of timber price risk, site productivity tax and yield tax are first developed. It is shown that, given the optimal site productivity tax, which is independent of the timber harvested and thus non-distortionary, it is desirable to introduce the yield tax at the margin; it both corrects externality due to the public goods characteristic of forest stands and serves as a social insurance device. The optimal yield tax is less than 100% and depends on the social value of forest stands, timber price risk and properties of compensated timber supply. In the general case the 'inverse elasticity rule – according to which the optimal yield tax is negatively related to the size of the substitution effects – may not hold. Under certainty, the desirability of the yield tax, given the optimal site productivity tax, depends only on the existence of public goods characteristic and is thus a pure Pigouvian tax.     

Pigouvian Taxation in Tourism

The paper studies the characteristics and the effects of a tax imposed by a local government on the land used to create new tourists' accommodations. First, a dynamic policy game between a monopolist in a tourist area and a local government is considered. In each period the former has to decide the size of land undergoing development, whereas the latter has to choose the tax to levy on each newly developed area unit. Linear Perfect Markov strategies are derived for both the non-cooperative and the public monopoly case. In equilibrium, a public monopoly would develop land more rapidly than a private monopoly. Furthermore, the more the monopolist discounts the future, the more the long run use of the natural resource is reduced. Second, the properties of the tax are studied considering an oligopolistic market structure. The tax alone does not lead to the socially optimal level of land use. However, its combined effect with another policy instrument such as a quota, induces the optimal level of resource use.     

Optimal taxation, global externalities and labor mobility

This paper concerns transboundary environmental problems in the context of an optimal tax model. We assume that part of the labor force is mobile across countries, and that the set of tax instruments includes a nonlinear income tax and a commodity tax on the ‘dirty’ good that is causing damage to the environment. The purpose is to compare the (globally optimal) second best policy of a cooperative equilibrium with the policy implicit in a noncooperative equilibrium. We show that the commodity taxes differ between equilibria because of: (i) transboundary externalities not internalized by national governments, (ii) interaction effects between environmental and other policies, and (iii) labor mobility.     

Optimal income taxation with human capital accumulation and limited record keeping

This paper characterizes optimal income taxes in a dynamic economy where human capital is unobservable and the government is restricted to use taxes that depend only on current income. I show that unobservability of human capital tends to decrease the labor wedge, while the effect on the human capital wedge is uncertain. I also analyze the relationship between optimal taxes in economies with and without endogenous human capital and identify two qualitative reasons why the optimal tax codes will differ. I perform numerical simulations to calculate the quantitative relevance of endogenous human capital formation for optimal tax policy. I find that endogenous human capital lowers marginal tax rates by about 9% on average, as compared with a static model without human capital.     

Marginal Tax Rates and Tax‐Favoured Pension Savings of the Self‐Employed: Evidence from Sweden*

In recent years, the study of how individuals respond to policies that aim at promoting pension savings has emerged as a vital area of economic research. This paper adds to this body of literature by estimating the tax price elasticity of contributions to tax‐favoured pension‐savings accounts on a population of self‐employed individuals. I exploit a unique total database over the Swedish population that covers the years 1999–2005. Using instrumental variables, I obtain a tax price elasticity estimate of ?0.51 and an income elasticity estimate of 0.13, whereas ordinary least‐squares (OLS) produces estimates that conflict with consumer theory.     

Social Comparisons and Optimal Taxation in a Small Open Economy

In this paper, we analyze how international capital mobility affects the optimal labor and capital income tax policy in a small open economy when consumers care about relative consumption. The main results crucially depend on whether the government can tax returns on savings abroad. If the government can use flexible residence‐based capital income taxes, then the optimal policy rules from a closed economy largely carry over to the case of a small open economy. If it cannot, then capital income taxes become completely ineffective. The labor income taxes must then indirectly also reflect the corrective purpose that the absent capital income tax would have had.     

Paternalism and Tax Competition

When consumers make mistakes, the government may wish to use paternalistic taxation as a corrective measure. We analyse the extent to which tax competition undermines the feasibility of paternalistic taxation. We show that the paternalistic component of a tax on a harmful good is reduced when there is cross-border shopping, but it does not disappear altogether. In a model with tax competition between two countries, only one of which has a paternalistic objective, we show that a minimum tax rate requirement can be Pareto improving despite the divergence in policy objectives. Tax harmonization, however, reduces welfare in the non-paternalistic country.     

Efficient Dynamic Pollution Taxation in an Uncertain Environment

This paper analyzes efficient pollution taxation within a stochastic model of endogenous growth. Pollution is a by-product of production and causes disutility. Furthermore, the productivity which results from environmental quality is uncertain. This reflects e.g. uncertain capital depreciation induced by natural disasters like hurricanes or floods. This uncertainty is shown to raise an ambiguous impact on the optimal pollution level as well as on optimal environmental taxation. Market equilibrium turns out to be suboptimal, since the households mis-perceive their individual impact on pollution. Conditions for welfare maximizing pollution taxation are stated and it is shown that a direct pollution tax is not appropriate to yield Pareto-optimal growth. Instead, a linear capital income tax together with a linear abatement subsidy build an efficient tax scheme, if secondarily the governmental budget is balanced. Moreover, an increase in the riskiness of environmental productivity may even lead to an increase in the optimal pollution level and to a decrease in optimal environmental taxation, depending predominantly on the preference parameters.      

Start-ups, venture capitalists, and the capital gains tax

A model of start-up finance with double moral hazard is proposed. Entrepreneurs have ideas and technical competence, but lack own resources as well as commercial experience. Venture capitalists (VCs) provide start-up finance and managerial support. Both types of agents thus jointly contribute to the firm's success, but neither type's effort is verifiable. We find that the market equilibrium is biased towards inefficiently low entrepreneurial effort and venture capital support. In this situation, the capital gains tax is particularly harmful. The introduction of a small tax impairs effort and advice and leads to a first-order welfare loss. Several other policies towards venture capital and start-up entrepreneurship are also investigated.     

Optimal Redistributive Income Taxation and Efficiency Wages*

In this paper, we integrate efficiency wage setting with the theory of optimal redistributive income taxation. In doing so, we use a model with two skill types, where efficiency wage setting characterizes the labor market faced by the low‐skilled, whereas the high‐skilled face a conventional, competitive labor market. We show that the marginal income tax implemented for the high‐skilled is negative under plausible assumptions. The marginal income tax facing the low‐skilled can be either positive or negative, in general. An increase in unemployment benefits contributes to a relaxation of the binding self‐selection constraint, which makes this instrument particularly useful from the perspective of redistribution.     

Redistribution and entrepreneurship with Schumpeterian growth

We examine the effects of redistributive taxation on growth and inequality in a Schumpeterian model with risk-averse agents. There are skilled and unskilled workers, and the growth rate is determined by the occupational choice of skilled agents between entrepreneurship and employment. We show that redistribution provides insurance to entrepreneurs and increases the growth rate. The effects on inequality are such that low tax rates increase inequality relative to laissez-faire due to changes in wages, but higher tax rates can simultaneously raise growth and reduce inequality. We contrast the optimal linear income tax with alternative policies for promoting R&D and find that it is preferable on both equity and efficiency grounds.      

Comparing ad valorem and specific taxes with corporate social responsibility

This paper examines the welfare ranking of indirect tax systems with corporate social responsibility (CSR) in a duopoly. Findings show that the two firms' cost and CSR asymmetries both play important roles. If the cost-efficient firm has a higher CSR level, the standard result in traditional tax theory is sustainable. Namely, ad valorem tax (specific subsidy) policies are considered superior to specific tax (ad valorem subsidy) policies. However, if the cost-inefficient firm has a significantly higher CSR level, the standard result is reversed. This result remains robust in an oligopoly model or under a tax revenue constraint.     

Financing education using optimal redistributive taxation

In this article, the joint use of an income tax and public provision of education as instruments to achieve the government’s distributional objectives is considered. Individuals differ in innate labour productivity and in aptitude to acquire skills through education. Actual labour productivity depends on both innate skill and the amount of education received. Using a generalized version of the Mirrlees tax problem that incorporates these features, qualitative properties of an optimal tax schedule are investigated.