Journal Article

Optimal Taxation with Private Government Information

Christopher Sleet

in The Review of Economic Studies

Published on behalf of Review of Economic Studies Ltd

Volume 71, issue 4, pages 1217-1239
Published in print October 2004 | ISSN: 0034-6527
Published online October 2004 | e-ISSN: 1467-937X | DOI: http://dx.doi.org/10.1111/0034-6527.00320
Optimal Taxation with Private Government Information

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  • Information, Knowledge, and Uncertainy
  • Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
  • Taxation, Subsidies, and Revenue

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The Ramsey model of fiscal policy implies that taxes should be smooth in the sense of having small variances. In contrast, empirical labour tax processes are smooth in the sense of being random walks; they provide prima facie evidence for incomplete government insurance. This paper considers whether private government information might lie behind such incomplete insurance. It shows that optimal incentive compatible policies exhibit limited use of state contingent debt and greater persistence in taxes and debt, and it argues that they are better approximations to empirical fiscal policies than those implied by the Ramsey model. The paper also establishes that optimal incentive compatible allocations converge to allocations such that the government's incentive compatibility constraint no longer binds. Generally, these limiting allocations are ones in which the government is maximally indebted. Their credibility and the interaction of incentive compatibility and credibility is briefly discussed.

Keywords: D82; E62; H21; H24

Journal Article.  10743 words.  Illustrated.

Subjects: Information, Knowledge, and Uncertainy ; Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook ; Taxation, Subsidies, and Revenue

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