Working Paper: NBER ID: w17319
Authors: Sanjay K. Chugh; Fabio Ghironi
Abstract: We study Ramsey-optimal fiscal policy in an economy in which product varieties are the result of forward-looking investment decisions by firms. There are two main results. First, depending on the particular form of variety aggregation in preferences, firms' dividend payments may be either subsidized or taxed in the long run. This policy balances monopoly incentives for product creation with consumers' welfare benefit of product variety. In the most empirically relevant form of variety aggregation, socially efficient outcomes entail a substantial tax on dividend income, removing the incentive for over-accumulation of capital, which takes the form of variety. Second, optimal policy induces dramatically smaller, but efficient, fluctuations of both capital and labor markets than in a calibrated exogenous policy. Decentralization requires zero intertemporal distortions and constant static distortions over the cycle. The results relate to Ramsey theory, which we show by developing welfare-relevant concepts of efficiency that take into account product creation.
Keywords: Optimal Fiscal Policy; Endogenous Product Variety; Ramsey Theory; Dividend Taxation
JEL Codes: E32; E62; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| optimal fiscal policy (E62) | efficient outcomes regarding product variety and capital accumulation (L23) |
| optimal dividend income tax (H21) | efficiency (D61) |
| substantial tax on dividend income (H24) | mitigates overaccumulation of capital driven by monopoly profits (E11) |
| tax smoothing (H20) | minimizes fluctuations in capital and labor markets (F16) |
| optimal policy (C61) | smaller fluctuations in capital and labor markets compared to calibrated exogenous policy (E39) |
| imposing a tax on dividend income (H29) | discourages excessive product development (L15) |