The New Dynamic Public Finance

The New Dynamic Public Finance

Narayana R. Kocherlakota
Copyright Date: 2010
Edition: STU - Student edition
Pages: 232
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  • Book Info
    The New Dynamic Public Finance
    Book Description:

    Optimal tax design attempts to resolve a well-known trade-off: namely, that high taxes are bad insofar as they discourage people from working, but good to the degree that, by redistributing wealth, they help insure people against productivity shocks. Until recently, however, economic research on this question either ignored people's uncertainty about their future productivities or imposed strong and unrealistic functional form restrictions on taxes. In response to these problems, the new dynamic public finance was developed to study the design of optimal taxes given only minimal restrictions on the set of possible tax instruments, and on the nature of shocks affecting people in the economy. In this book, Narayana Kocherlakota surveys and discusses this exciting new approach to public finance.

    An important book for advanced PhD courses in public finance and macroeconomics,The New Dynamic Public Financeprovides a formal connection between the problem of dynamic optimal taxation and dynamic principal-agent contracting theory. This connection means that the properties of solutions to principal-agent problems can be used to determine the properties of optimal tax systems. The book shows that such optimal tax systems necessarily involve asset income taxes, which may depend in sophisticated ways on current and past labor incomes. It also addresses the implications of this new approach for qualitative properties of optimal monetary policy, optimal government debt policy, and optimal bequest taxes. In addition, the book describes computational methods for approximate calculation of optimal taxes, and discusses possible paths for future research.

    eISBN: 978-1-4008-3527-0
    Subjects: Finance, Economics, Business

Table of Contents

  1. Front Matter
    (pp. i-iv)
  2. Table of Contents
    (pp. v-viii)
  3. Preface
    (pp. ix-xii)
  4. 1 Introduction
    (pp. 1-12)

    The goal of this book is to figure out at least some characteristics of the best possible tax system. This problem is a difficult one even to pose. The amount of tax that a typical citizen pays is a function of many economic variables. A far from exhaustive list includes labor earnings, interest income, dividend income, consumption, and money-holdings (via inflation). The dependence of collected taxes on these variables may be quite complicated. Moreover, taxes depend on asset incomes and asset holdings, and these represent the outcomes of decisions about how much wealth to transfer from one period to another....

  5. 2 The Ramsey Approach and Its Problems
    (pp. 13-33)

    The Ramsey approach was the dominant approach to dynamic optimal taxation (and, indeed, for discussions of much of macroeconomic policy) in the late twentieth century. The approach begins with the premise that taxes are distorting. It captures this distortion in the simplest possible fashion by assuming that all taxes are linear functions of current variables. It then chooses those tax rates to optimize social welfare (measured in some fashion). As we shall see, the Ramsey approach is remarkably tractable, which is one of its main attractions.

    In this chapter, I show how the Ramsey approach can be used to answer...

  6. 3 Basics of Dynamic Social Contracting
    (pp. 34-80)

    The Mirrleesian approach to optimal taxation is based on the premise that people differ in their abilities to produce, but taxes cannot be directly conditioned on those abilities. This premise implies that, from the point of the view of the tax system, people areprivately informedabout their skills. Since the goal of this book is to extend the Mirrleesian approach to dynamic economies, we have to understand properties of desirable allocations of resources in dynamic economies in which people are privately informed.

    In this chapter, I take up this task. I consider a class of economies with a large...

  7. 4 Dynamic Optimal Taxation: Lessons for Macroeconomists
    (pp. 81-139)

    In this chapter, we return to the fiscal policy issues that lay at the heart of chapter 2. I augment the model from that chapter so as to include agent heterogeneity and aggregate shocks to the aggregate production function. As in chapter 3, the agent heterogeneity takes the form of differences in skills (labor productivities), and these differences can fluctuate stochastically over time. Within this class of environments, I set up a canonical optimalnonlineartaxation problem for the government. I assume that the government has access to a complete record of the history of an agent’s labor incomes and...

  8. 5 Optimal Intergenerational Taxation
    (pp. 140-167)

    Chapter 4 described an optimal tax system given the presence of skill risk within a fixed cohort of individuals. The taxation of wealth plays a critical role in this system. In this chapter, we turn to the issue of how taxes should be structured in the presence ofintergenerationaltransmission of skills and assets. We will be especially interested in how governments should set bequest taxes¹ in this setting. The answer to this question is far from clear. Optimal taxes trade off incentives against insurance, and bequests affect this trade-off in a number of ways. On the one hand, bequests...

  9. 6 Quantitative Analysis: Methods and Results
    (pp. 168-200)

    The preceding chapters provide qualitative characterizations of optimal tax systems. These characterizations are robust, in the sense in that they are applicable for a wide class of shock processes and preferences, but partial. I now take up a different question. Suppose we have a quantitative specification of primitives (preferences, technology, and the law of motion of shocks) for a particular economy. How do we translate this information about primitives into a complete specification of an optimal tax system for this economy?

    The analysis in chapters 4 and 5 is key to answering this question. That discussion shows how we can...

  10. 7 The Way Forward
    (pp. 201-214)

    In the preceding chapters, I have provided a survey of the current state of the new dynamic public finance. Much has been accomplished in a relatively short period, but there is certainly more to be done. In this chapter, I discuss what strike me as promising directions for future research. I focus on tax systems that are more widely applicable, on better solution methods, and on what information we need from the data to implement the new dynamic public finance.

    I show in chapters 4 and 5 that, given any data-generation process for skills, we can design a class of...

  11. Index
    (pp. 215-217)