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School of Economics and Finance

No. 857: Time-Consistent Consumption Taxation

Sarolta Laczo , Queen Mary University of London
Raffaele Rossi , University of Manchester, Department of Economics

April 12, 2018

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Abstract

We characterise optimal tax policies when the government has access to consumption taxation and cannot credibly commit to future policies. We consider a neoclassical economy where factor income taxation is distortionary within the period, due to endogenous labour and capital utilisation and non-tax-deductibility of depreciation. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies with consumption taxation are remarkably similar to their Ramsey counterparts. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment.

J.E.L classification codes: E62, H21

Keywords:fiscal policy, Markov-perfect policies, consumption taxation, variable capital utilisation

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