A Parametric Example

The current this chapter provides a parametric example based on the theory developed in the previous chapter. The impact of changes in the tax rate on the desire to work is assessed. The agents maximize their lifetime, indirectly utilizing the function based upon the changes in the tax rate. It is shown that the optimal choice of tax rate is stationary and the tax rates chosen in a closed–loop regime are lower than those of open–loop equilibria. Four equations are derived to completely describe the political economy in a Markovian equilibrium. The existence of uniquely stable, steady–state equivalence relationship of the restricted payoff function provides a solution to the Markovian equilibrium, which is unique and stable. The parameters from the four equations—namely the discount factor, the ratio of median–mean ability, and the institutional parameter—are calibrated; then iterative computer simulation is performed. The simulation determines the steady–state equilibrium distribution of assets and the tax rate. The convergence and stability of the simulation are found to be consistent with the assumptions of the model.