Working Paper: NBER ID: w11185
Authors: Mikhail Golosov; Aleh Tsyvinski
Abstract: We study optimal tax policy in a dynamic private information economy with endogenous private markets. We characterize efficient allocations and competitive equilibria. A standard assumption in the literature is that trades are observable by all agents. We show that in such an environment the competitive equilibrium is efficient. The only effect of government interventions is crowding out of private insurance. We then relax the assumption of observability of consumption and consider an environment with unobservable trades in competitive markets. We show that efficient allocations have the property that the marginal product of capital is different from the market interest rate associated with unobservable trades. In any competitive equilibrium without taxation, the marginal product of capital and the market interest rate are equated, so that competitive equilibria are not efficient. Taxation of capital income can be welfare-improving because such taxation introduces a wedge between market interest rates and the marginal product of capital and allows agents to obtain better insurance in private markets. Finally, we use plausibly calibrated numerical examples to compute optimal taxes and welfare gains and compare results to an economy with a restricted set of tax instruments, and to an economy with observable trades.
Keywords: Optimal Taxation; Endogenous Insurance Markets; Welfare Economics
JEL Codes: E62; H21; H23; H53
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government interventions (E65) | crowd out private insurance (I13) |
| Public insurance (I13) | reduce amount of insurance provided by private markets (G52) |
| Taxation of capital income (H24) | improve welfare (I30) |
| Distortionary taxes (H31) | create a wedge between market interest rates and marginal product of capital (D33) |
| Wedge between market interest rates and marginal product of capital (D33) | enhance insurance provided by private markets (G52) |
| Positive linear taxes on capital income (H31) | lower return on savings (D14) |
| Lower return on savings (D14) | incentivize agents to reveal private information truthfully (D82) |
| Interaction between private insurance markets and public tax policy (H29) | affect insurance provided through private markets (G52) |