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

RePEc Short ID: pch650
ORCID iD: 0000-0002-6820-1197

Chen, Yunmin; Chien, YiLi; Owyang, Michael T.

doi:10.20955/wp.2017.003

Working Paper

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. We first show that the Aiyagari?s result holds if the shadow price of raising government revenues through distorting taxes converges to zero in the limit at the Ramsey optimum. This ?if? is clearly a strong condition. As long as the condition fails to hold, we show (i) there is no Ramsey steady state when the elasticity of intertemporal substitution (EIS) is weakly less than 1, and (ii) a Ramsey steady state is possible if EIS is larger than 1 but the MGR does not hold and the corresponding capital tax is non-positive. The key to our non-existence result 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;

https://doi.org/10.20955/wp.2017.003