In a dynamic economy whose government is interested in both equity and efficiency, time consistency problems arise even if the government has access to nondistortionary tax instruments. Moral hazard in production leads to a nondegenerate distribution of income, which the government would like to "flatten" ex post. Self-enforcing social agreements can mitigate the tendency toward excessive redistribution. We investigate the nature of the distortions caused by the time consistency problem, and show that in the constrained-optimal equilibrium, usually alineartax schedule is imposed. This remains true if renegotiation of the social agreement is possible.Journal of Economic LiteratureClassification Numbers: C7 C73, E6, H21.
ASJC Scopus subject areas
- Economics and Econometrics