Hostname: page-component-77c89778f8-m42fx Total loading time: 0 Render date: 2024-07-20T02:49:24.689Z Has data issue: false hasContentIssue false
  • English
  • Français

Optimal fiscal policy under capital overaccumulation

Published online by Cambridge University Press:  24 August 2022

YiLi Chien  and
Yi Wen
YiLi Chien
Affiliation:
Research Division, Federal Reserve Bank of St. Louis, P.O. Box 442, St. Louis, MO, 63166-0442, USA
Yi Wen*
Affiliation:
Antai College of Economics and Management, Shanghai Jiaotong University, Shanghai, China
*
*Corresponding author. Email: wenyi001@sjtu.edu.cn
Get access Rights & Permissions [Opens in a new window]

Abstract

In a canonical model of heterogeneous agents with precautionary saving motives, Aiyagari [(1995) Journal of Political Economy 103(6), 1158–1175.] breaks the classical result of zero capital tax obtained in representative-agent models. Aiyagari argues that with capital overaccumulation the optimal long-run capital tax should be strictly positive in order to achieve aggregate allocative efficiency suggested by the modified golden rule (MGR). In this paper, we find that, depending on the sources of capital overaccumulation, capital taxation may not be the most efficient means to restore the MGR when government debt is feasible. To demonstrate our point, we study optimal policy mix in achieving the socially optimal (MGR) level of aggregate capital stock in an infinite horizon heterogeneous-agents incomplete-markets economy where capital may be overaccumulated for two distinct reasons: (i) precautionary savings and (ii) production externalities. By solving the Ramsey problem analytically along the entire transitional path, we reveal that public debt and capital taxation play very distinct roles in dealing with the overaccumulation problem. The Ramsey planner opts neither to use a capital tax to correct the overaccumulation problem if it is caused solely by precautionary saving—regardless of the feasibility of public debt—nor to use debt (financed by consumption tax) to correct the overaccumulation problem if it is caused solely by production externality (such as pollution)—regardless of the feasibility of a capital tax. The key is that the MGR has two margins: an intratemporal margin pertaining to the marginal product of capital (MPK) and an intertemporal margin pertaining to the time discount rate. To achieve the MGR, the Ramsey planner needs to equate not only the private MPK with the social MPK but also the interest rate with the time discount rate—neither of which is equalized in a competitive equilibrium. Yet public debt and a capital tax are each effective only in calibrating one of the two margins, respectively, but not both.

Keywords

Optimal quantity of debtcapital taxationRamsey problemheterogeneous agentsincomplete marketspollutionproduction externalities
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 6 , September 2023 , pp. 1706 - 1736
Copyright
© The Author(s), 2022. Published by Cambridge University Press

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Aiyagari, S. R. (1994) Uninsured idiosyncratic risk and aggregate saving. Quarterly Journal of Economics 109(3), 659–684.CrossRefGoogle Scholar
Aiyagari, S. R. (1995) Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting. Journal of Political Economy 103(6), 1158–1175.CrossRefGoogle Scholar
Aiyagari, S. R. and McGrattan, E. R. (1998) The optimum quantity of debt. Journal of Monetary Economics 42(3), 447–469.CrossRefGoogle Scholar
Angeletos, G.-M., Collard, F. and Dellas, H. (2020) Public Debt as Private Liquidity: Optimal Policy, CEPR Discussion Papers 15488, C.E.P.R Discussion Papers.Google Scholar
Barro, R. J. (1979) On the determination of the public debt. Journal of Political Economy 87(5), 940–971.CrossRefGoogle Scholar
Bassetto, M. and Cui, W. (2020) A Ramsey Theory of Financial Distortions, Working Papers 775, Federal Reserve Bank of Minneapolis,CrossRefGoogle Scholar
Chamley, C. (1986) Optimal taxation of capital income in general equilibrium with infinite lives. Econometrica 54(3), 607–622.10.2307/1911310CrossRefGoogle Scholar
Chari, V. and Kehoe, P. J. (1999) Optimal fiscal and monetary policy. In: Chari, V. and Kehoe, P. J.. (eds.), Handbook of Macroeconomics, Chapter 26, pp. 1671–1745, Elsevier.Google Scholar
Chari, V. V., Atkeson, A. and Kehoe, P. J. (1999) Taxing capital income: A bad idea. Quarterly Review 23(3), 3–17.10.21034/qr.2331CrossRefGoogle Scholar
Chari, V. V., Christiano, L. J. and Kehoe, P. J. (1996) Optimality of the Friedman rule in economies with distorting taxes. Journal of Monetary Economics 37(2-3), 203–223.CrossRefGoogle Scholar
Chen, B.-L. and Lu, C.-H. (2013) Optimal factor tax incidence in two-sector human capital-based models. Journal of Public Economics 97(C), 75–94.CrossRefGoogle Scholar
Chien, Y. and Wen, Y. (2021) Optimal Ramsey taxation in heterogeneous agent economies with quasi-linear preferences. Review of Economic Dynamics, Forthcoming 109, 659.Google Scholar
Cropper, M. and Oates, W. (1992) Environmental economics: A survey. Journal of Economic Literature 30(2), 675–740.Google Scholar
Gottardi, P., Kajii, A. and Nakajima, T. (2015) Optimal taxation and debt with uninsurable risks to human capital accumulation. American Economic Review 105(11), 3443–3470.CrossRefGoogle Scholar
Ljungqvist, L. and Sargent, T. J. (2012) Recursive Macroeconomic Theory, The MIT Press.Google Scholar
Lucas, R. E. (1990) Supply-side economics: An analytical review. Oxford Economic Papers 42(2), 293–316.CrossRefGoogle Scholar
Lucas, R. J. and Stokey, N. L. (1983) Optimal fiscal and monetary policy in an economy without capital. Journal of Monetary Economics 12(1), 55–93.CrossRefGoogle Scholar