Working Paper Revision

Implementing the Modified Golden Rule? Optimal Ramsey Capital Taxation with Incomplete Markets Revisited

Abstract: What is the prescription of Ramsey capital taxation in the long run? Aiyagari (1995) addressed the question in a heterogeneous-agent incomplete-markets (HAIM) economy, showing that a positive capital tax should be imposed to implement the so-called modified golden rule (MGR). This paper revisits the long-standing issue. Working with commonly used separable isoelastic preferences, we show (i) the multiplier on the resource constraint of the Ramsey problem must diverge in the limit if a Ramsey steady state exists, (ii) there is no Ramsey steady state when the elasticity of intertemporal substitution (EIS) is weakly less than 1, and (iii) a Ramsey steady state is possible if the EIS is larger than 1 but the MGR does not hold and the corresponding capital tax is non-positive. The key to our results is embedded in the hallmark of the HAIM economy: the risk-free gross interest rate is lower than the inverse of the preference discount factor in steady state.

Keywords: Capital Taxation; Modified Golden Rule; Ramsey Problem; Incomplete Markets;

JEL Classification: C61; E22; E62; H21; H30;

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Bibliographic Information

Provider: Federal Reserve Bank of St. Louis

Part of Series: Working Papers

Publication Date: 2020-04-15

Number: 2017-003

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