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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 ...
Working Paper
Don’t Tax Capital — Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences
We build a tractable heterogeneous-agent incomplete-markets model with quasi-linear preferences to address a set of long-standing issues in the optimal Ramsey taxation literature. The tractability of our model enables us to analytically prove the existence of a Ramsey steady state and establish several novel results: (i) In the absence of any redistributional effects of capital taxation or lump-sum transfers, the optimal capital tax is exclusively zero in a Ramsey steady state regardless of the modified golden rule (MGR) and government debt limits. (ii) Whether the MGR holds or not depends ...
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
Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk
A positive national debt is often rationalized either by the assumption of dynamic inefficiency in an overlapping-generations (OLG) model, or by the hypothesis of heterogeneous-agents and incomplete-markets (HAIM) in an infinite horizon model. Both assumptions imply insufficient private liquidity to support private saving and investment, thus calling for a positive level of public debt to improve social welfare. However, since public debt is financed often by distortionary future taxes, optimal debt and tax policies ought to be studied jointly in a single framework. In this paper we use a ...
Working Paper
Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk
A positive national debt is often rationalized either by the assumption of dynamic inefficiency in an overlapping-generations (OLG) model, or by the hypothesis of heterogeneous-agents and incomplete-markets (HAIM) in an infinite horizon model. Both assumptions imply insufficient private liquidity to support private saving and investment, thus calling for a positive level of public debt to improve social welfare. However, since public debt is financed often by distortionary future taxes, optimal debt and tax policies ought to be studied jointly in a single framework. In this paper we use a ...
Working Paper
Are Government Bonds Net Wealth or a Liability? ---Optimal Debt and Taxes in an OLG Model with Uninsurable Income Risk
The rapidly growing national debt in the U.S. since the 1970s has alarmed and intrigued the academic world. Consequently, the concept of dynamic (in)efficiency in an overlapping generations (OLG) world and the importance of the heterogeneous-agents and incomplete markets (HAIM) hypothesis to justify a high debt-to-GDP ratio have been extensively studied. Two important consensus emerge from this literature: (i) The optimal quantity of public debt is positive—due to insufficient private liquidity to support private saving and investment (see, e.g., Barro (1974), Woodford (1990), and Aiyagari ...
Working Paper
Optimal Ramsey Capital Income Taxation —A Reappraisal
This paper addresses a long-standing problem in the optimal Ramsey capital taxation literature. The tractability of our model enables us to solve the Ramsey problem analytically along the entire transitional path. We show that the conventional wisdom on Ramsey tax policy and its underlying intuition and rationales do not hold in our model and may thus be misrepresented in the literature. We uncover a critical trade off for the Ramsey planner between aggregate allocative efficiency in terms of the modified golden rule and individual allocative efficiency in terms of self-insurance. Facing the ...
Working Paper
Time-Inconsistent Optimal Quantity of Debt
A key property of the Aiyagari-type heterogeneous-agent models is that the equilibrium interest rate of public debt lies below the time discount rate. This fundamental property, however, implies that the Ramsey planner's fiscal policy may be time-inconsistent because the forward-looking planner would have a dominate incentive to issue plenty of debt, such that all households are fully self-insured against idiosyncratic risk whenever the interest rate of government borrowing is lower than the household time discount rate. But such a full self-insurance allocation may be paradoxical because, to ...
Working Paper
Optimal Ramsey Taxation in Heterogeneous Agent Economies with Quasi-Linear Preferences
We build a tractable heterogeneous-agent incomplete-markets model with quasi-linear preferences to address a set of long-standing issues in the optimal Ramsey taxation literature. The tractability of our model enables us to analytically prove the existence of the Ramsey steady state and establish several novel results: (i) The failure of the modified golden rule (MGR) cannot by itself justify a positive steady-state capital tax---we prove that in the absence of wealth-redistribution effects the optimal capital tax is exclusively zero in the Ramsey steady state regardless of the validity of ...
Working Paper
Are Unconditional Lump-sum Transfers a Good Idea?
The role of unconditional lump-sum transfers in improving social welfare in heterogenous agent models has not been thoroughly understood in the literature. We adopt an analytically tractable Aiyagari-type model to study the distinctive role of unconditional lump-sum transfers in reducing consumption inequality due to ex-post uninsurable income risk. Our results show that in the presence of ex-post heterogeneity and in the absence of wealth inequality, unconditional lump-sum transfers are not a desirable tool for reducing consumption inequality—the Ramsey planner opts to rely solely on ...