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Optimal Dynamic Nonlinear Income Taxation under Loose Commitment

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  • Jang-Ting Guo
  • Alan Krause

Abstract

This paper examines an infinite-horizon model of dynamic nonlinear income taxation in which there exists a small probability that the government cannot commit to its future tax policy. In this "loose commitment" environment, we find that even a little uncertainty over whether the government can commit yields substantial effects on the optimal dynamic nonlinear income tax system. Under an empirically plausible parameterization, numerical simulations show that high-skill individuals must be subsidized in the short run, despite the government's redistributive objective, unless the probability of commitment is higher than 98%. Loose commitment also reverses the short-run welfare effects of changes in most model parameters. In particular, all individuals are worse-off, rather than better-off, in the short run when the proportion of high-skill individuals in the economy increases. Finally, our main findings remain qualitatively robust to a setting in which loose commitment is modelled as a Markov switching process.

Suggested Citation

  • Jang-Ting Guo & Alan Krause, 2010. "Optimal Dynamic Nonlinear Income Taxation under Loose Commitment," Discussion Papers 10/23, Department of Economics, University of York.
    • Handle: RePEc:yor:yorken:10/23
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    References listed on IDEAS

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    1. Jang‐Ting Guo & Alan Krause, 2011. "Optimal Nonlinear Income Taxation with Habit Formation," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 13(3), pages 463-480, June.
    2. Guo, Jang-Ting & Krause, Alan, 2015. "Dynamic income taxation without commitment: Comparing alternative tax systems," Economic Modelling, Elsevier, vol. 47(C), pages 319-326.
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    Cited by:

    1. Jang-Ting Guo & Alan Krause, 2018. "Changing social preferences and optimal redistributive taxation," Oxford Economic Papers, Oxford University Press, vol. 70(1), pages 73-92.
    2. Alan Krause, 2017. "On redistributive taxation under the threat of high-skill emigration," Social Choice and Welfare, Springer;The Society for Social Choice and Welfare, vol. 48(4), pages 845-856, April.
    3. Guo, Jang-Ting & Krause, Alan, 2015. "Dynamic income taxation without commitment: Comparing alternative tax systems," Economic Modelling, Elsevier, vol. 47(C), pages 319-326.
    4. Chen, Yunmin & Guo, Jang-Ting & Krause, Alan, 2020. "The credibility of commitment and optimal nonlinear savings taxation," Journal of Macroeconomics, Elsevier, vol. 65(C).
    5. Yuhn, Ky-hyang & Bennett, Christopher S., 2016. "A Note On The Bush Tax Cuts: Did They Succeed In Stimulating Business Investment?," Macroeconomic Dynamics, Cambridge University Press, vol. 20(6), pages 1623-1639, September.
    6. Shigeo Morita & Takuya Obara, 2021. "Public investment criteria under optimal nonlinear income taxation without commitment," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 23(4), pages 732-745, August.

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    More about this item

    Keywords

    Dynamic Income Taxation; Loose Commitment;

    JEL classification:

    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies

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