Seminar Paper / Institute for International Economic Studies, Stockholm University

This paper presents a model of optimal taxation that is useful for understanding governments' incentives to switch from wage to consumption taxation. The key ingredient is the fact that governments cannot precommit policy: although under precommitment governments would tax only wages, there is an (ex post) incentive to switch to the consumption tax as savings grows. Numerical examples for a nested CES utility function find that for reasonable parameter values, equilibrium features a switch to consumption taxation: in particular, the model produces this tax reform when parameterized as in Auerbach and Kotlikoff's (1987) study. Published in connection with a visit at the IIES. This paper presents a model of optimal taxation that is useful for understanding governments' incentives to switch from wage to consumption taxation. The key ingredient is the fact that governments cannot precommit policy: although under precommitment governments would tax only wages, there is an (ex post) incentive to switch to the consumption tax as savings grows. Numerical examples for a nested CES utility function find that for reasonable parameter values, equilibrium features a switch to consumption taxation: in particular, the model produces this tax reform when parameterized as in Auerbach and Kotlikoff's (1987) study. Published in connection with a visit at the IIES.