Chapter 15 Optimal Taxation with Commitment . Introduction This chapter formulates a dynamic optimal taxation problem called a Ramsey problem with a solution called a Ramsey plan. The government’s goal is to maximize households’ welfare subject to raising set revenues through distortionary taxation. | Chapter 15 Optimal Taxation with Commitment . Introduction This chapter formulates a dynamic optimal taxation problem called a Ramsey problem with a solution called a Ramsey plan. The government s goal is to maximize households welfare subject to raising set revenues through distortionary taxation. When designing an optimal policy the government takes into account the equilibrium reactions by consumers and firms to the tax system. We first study a nonstochastic economy then a stochastic economy. The model is a competitive equilibrium version of the basic neoclassical growth model with a government that finances an exogenous stream of government purchases. In the simplest version the production factors are raw labor and physical capital on which the government levies distorting flat-rate taxes. The problem is to determine the optimal sequences for the two tax rates. In a nonstochastic economy Chamley 1986 and Judd 1985b show in related settings that if an equilibrium has an asymptotic steady state then the optimal policy is eventually to set the tax rate on capital to zero. This remarkable result asserts that capital income taxation serves neither efficiency nor redistributive purposes in the long run. This conclusion is robust to whether the government can issue debt or must run a balanced budget in each period. However if the tax system is incomplete the limiting value of optimal capital tax can be different from zero. To illustrate this possibility we follow Correia 1996 and study a case with an additional fixed production factor that cannot be taxed by the government. In a stochastic version of the model with complete markets we find indeterminacy of state-contingent debt and capital taxes. Infinitely many plans implement the same competitive equilibrium allocation. For example two alternative extreme cases are 1 that the government issues risk-free bonds and lets the capital tax rate depend on the current state or 2 that it fixes the capital tax rate one .
