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Working Paper
Implementing the Modified Golden Rule? Optimal Ramsey Capital Taxation with Incomplete Markets Revisited
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 ...
Working Paper
Implementing the Modified Golden Rule? Optimal Ramsey Capital Taxation with Incomplete Markets Revisited
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). In deriving the MGR result, Aiyagari (1995) implicitly assumed that the multiplier on the resource constraint of the Ramsey problem converges to a finite positive value in the limit. We first show that this implicit assumption has a strong implication for the shadow price of Ramsey taxation in the limit: it must go to ...
Working Paper
Implementing the Modified Golden Rule? Optimal Ramsey Capital Taxation with Incomplete Markets Revisited
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 ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We analyze the Ramsey planner's decisions to finance stochastic public expenditures under incomplete insurance markets for idiosyncratic risk. We show analytically that whenever the market interest rate lies below the time discount rate, the Ramsey planner has a dominant incentive to increase debt to meet the private sector's demand for full self-insurance regardless of the relative size of aggregate shocks---suggesting a departure from tax smoothing. However, if a full self-insurance Ramsey allocation is infeasible in the absence of a government debt limit, an interior or bounded Ramsey ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable model to show that the Ramsey planner's decisions to finance stochastic public expenditures under uninsurable idiosyncratic risk implies a departure from tax smoothing. In the absence of state-contingent bonds the government's attempt to balance the competing incentives between tax smoothing and individual consumption smoothing---even at the cost of extra tax distortion---implies a bounded stochastic unit root component in optimal taxes. Nonetheless, a sufficiently high average level of public debt to support individuals’ self-insurance position is welfare ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable model to show that the Ramsey planner's decisions to finance stochastic public expenditures under uninsurable idiosyncratic risk implies a departure from tax smoothing. In the absence of state-contingent bonds the government's attempt to balance the competing incentives between tax smoothing and individual consumption smoothing---even at the cost of extra tax distortion---implies a bounded stochastic unit root component in optimal taxes. Nonetheless, a sufficiently high average level of public debt to support individuals’ self-insurance position is welfare ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable, heterogeneous-agent incomplete-markets model to show that the Ramsey planner’s decision to finance stochastic public expenditures implies a departure from tax smoothing and an endogeneous mean-reverting force to support positive debt growth despite the government’s precautionary saving motives. Specifically, the government’s attempt to balance the competing incentives between its own precautionary saving (tax smoothing) and households’ precautionary saving (individual consumption smoothing)—even at the cost of extra tax distortion—implies an ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We use an analytically tractable, heterogeneous-agent incomplete-markets model to show that the Ramsey planner's decision to finance stochastic public expenditures implies a departure from tax smoothing and an endogenous mean-reverting force to support positive debt growth despite the government's precautionary saving motives. Specifically, the government's attempt to balance the competing incentives between its own precautionary saving (tax smoothing) and households' precautionary saving (individual consumption smoothing)---even at the cost of extra tax distortion---implies an endogenous, ...
Working Paper
The Determination of Public Debt under both Aggregate and Idiosyncratic Uncertainty
We analyze the Ramsey planner's decisions to finance stochastic public expenditures under incomplete insurance markets for idiosyncratic risk. We show analytically that whenever the market interest rate lies below the time discount rate, the Ramsey planner has a dominant incentive to increase debt to meet the private sector's demand for full self-insurance regardless of the relative size of aggregate shocks---suggesting a departure from tax smoothing. However, if a full self-insurance Ramsey allocation is infeasible in the absence of a government debt limit, an interior or bounded Ramsey ...
Working Paper
Optimal Fiscal Policies under Market Failures
The aggregate capital stock in a nation can be overaccumulated for many different reasons. This paper studies which policy or policy mix is more effective in achieving the socially optimal (modified golden rule) level of aggregate capital stock in an infinite-horizon heterogeneous-agents incomplete-markets economy where capital may be over-accumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we show that public debt and capital taxation play very distinct roles in ...