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Constrained Inefficiency and Optimal Taxation with Uninsurable Risks
Author(s) -
GOTTARDI PIERO,
KAJII ATSUSHI,
NAKAJIMA TOMOYUKI
Publication year - 2016
Publication title -
journal of public economic theory
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.809
H-Index - 32
eISSN - 1467-9779
pISSN - 1097-3923
DOI - 10.1111/jpet.12135
Subject(s) - economics , inefficiency , welfare , capital (architecture) , general equilibrium theory , lump sum , distribution (mathematics) , income tax , labour economics , monetary economics , microeconomics , public economics , payment , finance , mathematical analysis , mathematics , archaeology , market economy , history
When individuals' labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two‐period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks and the degree of heterogeneity among consumers' income, as well as on the way in which the tax revenue is used to provide lump‐sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However, in other cases a negative tax on capital is welfare‐improving.