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Optimal Taxation with Persistent Shocks

Author

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  • Marek Kapicka

    (Economics University of California Santa Barbara)

Abstract

In this paper I study dynamic optimal taxation in a private information economy with continuum of individual productivity shocks that are persistent over time. I formulate the problem recursively and use first order approach to simplify it. I provide full justification of the first order approach. The advantage of the first order approach is twofold. First, as is well known, it simplifies the incentive compatibility constraint. Second, and this is a new feature in this model, it dramatically reduces the state space of the dynamic program. Instead of using the continuation utility function as a state, we use the marginal continuation utility as a state. This feature is extremely useful because it allows us to numericaly implement the dynamic program and solve quantitatively for the optimal allocations
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Suggested Citation

  • Marek Kapicka, 2005. "Optimal Taxation with Persistent Shocks," 2005 Meeting Papers 204, Society for Economic Dynamics.
    • Handle: RePEc:red:sed005:204
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    Cited by:

    1. Marek Kapicka, 2006. "Optimal Income Taxation with Human Capital Accumulation and Limited Record Keeping," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(4), pages 612-639, October.
    2. Yuzhe Zhang, 2005. "Dynamic contracting, persistent shocks and optimal taxation," Working Papers 640, Federal Reserve Bank of Minneapolis.

    More about this item

    JEL classification:

    • E1 - Macroeconomics and Monetary Economics - - General Aggregative Models
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H2 - Public Economics - - Taxation, Subsidies, and Revenue

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