Working Paper: CEPR ID: DP16616
Authors: Andrea Lanteri; Alex Clymo; Alessandro Villa
Abstract: We analyze optimal capital and labor taxes in a model where (i) the government makes noncontingent announcements about future policies and (ii) ex-post state-contingent deviations from these announcements are costly.With Full Commitment, optimal fiscal announcements are unbiased forecasts of future taxes. Costly state contingency dampens the response of both current and future capital taxes to government spending shocks, because the government uses announcements about future taxes to stimulate current output. Labor taxes play a major role in accommodating fiscal shocks. This mechanism allows the model to successfully match the empirical volatility of tax rates.In the absence of Full Commitment, optimal fiscal announcements are strategically biased. Costly state contingency generates an endogenous degree of fiscal commitment, leading to a positive, but low average capital tax---approximately 8% in our calibrated model.
Keywords: optimal fiscal policy; fiscal announcements; costly state contingency; time inconsistency
JEL Codes: No JEL codes provided
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal fiscal announcements (E62) | unbiased forecasts of future taxes (H68) |
| government spending shocks (E62) | future taxes (H29) |
| costly state contingency (H79) | response of capital taxes to government spending shocks (H30) |
| government spending increases (H59) | labor taxes adjusted more rapidly and persistently compared to capital taxes (H31) |
| absence of full commitment (J22) | optimal fiscal announcements become strategically biased (E62) |
| strategically biased fiscal announcements (E62) | low average capital tax (H29) |
| costs associated with deviating from prior announcements (G14) | capital taxes do not rise as much (H29) |