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Optimal taxation in life-cycle economies

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Andres Erosa
Martin Gervais

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Abstract

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 non-zero tax on capital income is also optimal, as it can (imperfectly) mimic age-conditioned consumption and labor income tax rates.

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Paper provided by Federal Reserve Bank of Richmond in its series Working Paper with number 00-02.

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Date of creation: 2000
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Handle: RePEc:fip:fedrwp:00-02

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Keywords: Taxation;

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References listed on IDEAS
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  1. Auerbach, Alan J & Kotlikoff, Laurence J & Skinner, Jonathan, 1983. "The Efficiency Gains from Dynamic Tax Reform," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 24(1), pages 81-100, February. [Downloadable!] (restricted)
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  2. Paul Klein & JosÈ-VÌctor RÌos-Rull, 2003. "Time-consistent optimal fiscal policy," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 44(4), pages 1217-1245, November. [Downloadable!] (restricted)
  3. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Ghiglino, Christian & Tvede, Mich, 2000. "Optimal Policy in OG Models," Journal of Economic Theory, Elsevier, vol. 90(1), pages 62-83, January. [Downloadable!] (restricted)
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  5. Summers, Lawrence H, 1981. "Capital Taxation and Accumulation in a Life Cycle Growth Model," American Economic Review, American Economic Association, vol. 71(4), pages 533-44, September. [Downloadable!] (restricted)
  6. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May. [Downloadable!] (restricted)
  7. Krusell, Per & Quadrini, Vincenzo & Rios-Rull, Jose-Victor, 1996. "Are consumption taxes really better than income taxes?," Journal of Monetary Economics, Elsevier, vol. 37(3), pages 475-503, June. [Downloadable!] (restricted)
  8. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June. [Downloadable!] (restricted)
  9. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April. [Downloadable!] (restricted)
  10. V. V. Chari & Patrick J. Kehoe, 1998. "Optimal fiscal and monetary policy," Staff Report 251, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  11. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1994. "Optimal Fiscal Policy in a Business Cycle Model," Journal of Political Economy, University of Chicago Press, vol. 102(4), pages 617-52, August. [Downloadable!] (restricted)
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  12. Imrohoroglu, Selahattin, 1998. "A Quantitative Analysis of Capital Income Taxation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(2), pages 307-28, May.
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  13. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93. [Downloadable!] (restricted)
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  14. Marco Bassetto, 1999. "Political economy of taxation in an overlapping-generations economy," Discussion Paper / Institute for Empirical Macroeconomics 133, Federal Reserve Bank of Minneapolis. [Downloadable!]
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  15. Judd, Kenneth L., 1999. "Optimal taxation and spending in general competitive growth models," Journal of Public Economics, Elsevier, vol. 71(1), pages 1-26, January. [Downloadable!] (restricted)
  16. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, vol. 90(359), pages 529-49, September. [Downloadable!] (restricted)
  17. Laurence J. Kotlikoff, 1998. "The A-K Model: It's Past, Present, and Future," NBER Working Papers 6684, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  18. Kydland, Finn E & Prescott, Edward C, 1977. "Rules Rather Than Discretion: The Inconsistency of Optimal Plans," Journal of Political Economy, University of Chicago Press, vol. 85(3), pages 473-91, June. [Downloadable!] (restricted)
  19. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science. [Downloadable!]
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  20. Besley, Timothy & Jewitt, Ian, 1995. "Uniform taxation and consumer preferences," Journal of Public Economics, Elsevier, vol. 58(1), pages 73-84, September. [Downloadable!] (restricted)
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