Optimal taxation without state-contingent debt

S. Rao Aiyagari, Albert Marcet, Thomas J. Sargent, Juha Seppälä

    Research output: Contribution to journalArticlepeer-review

    Abstract

    In an economy studied by Lucas and Stokey, tax rates inherit the serial correlation structure of government expenditures, belying Barro's earlier result that taxes should be a random walk for any stochastic process of government expenditures. To recover a version of Barro's random walk tax-smoothing outcome, we modify Lucas and Stokey's economy to permit only risk-free debt. Having only risk-free debt confronts the Ramsey planner with additional constraints on equilibrium allocations beyond one imposed by Lucas and Stokey's assumption of complete markets. The Ramsey outcome blends features of Barro's model with Lucas and Stokey's. In our model, the contemporaneous effects of exogenous government expenditures on the government deficit and taxes resemble those in Lucas and Stokey's model, but incomplete markets put a near-unit root component into government debt and taxes, an outcome like Barro's. However, we show that without ad hoc limits on the government's asset holdings, outcomes can diverge in important ways from Barro's. Our results use and extend recent advances in the consumption-smoothing literature.

    Original languageEnglish (US)
    Pages (from-to)1220-1254
    Number of pages35
    JournalJournal of Political Economy
    Volume110
    Issue number6
    DOIs
    StatePublished - Dec 2002

    ASJC Scopus subject areas

    • Economics and Econometrics

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