Taxation without Commitment in a Heterogenous-Agent Economy

Speaker: Dr Youngsoo Jang

Affiliation: The University of Queensland

Location: Room 629, Level 6, Colin Clark Bld #39, UQ St Lucia Campus

Abstract 

How do differences in the government's political and commitment structure affect the aggregate economy, inequality, and welfare? I examine this question in a standard incomplete markets model with uninsurable idiosyncratic income risk, where a flat tax rate and transfers are endogenously determined according to a government's political and commitment structure. I compare the following three economies over the transitional path: an economy with the optimal tax with commitment; an economy with the optimal tax without commitment; and a political economy with sequential majority voting. I characterize the Markov perfect equilibria of the cases without commitment, thereby demonstrating how the government's policy decisions interact with individual heterogeneity. Additionally, through quantitative exercises, I obtain two main findings. First, a lack of commitment hinders the government from managing the evolution of inequalities in the long run but instead makes it pursue more income with a lower tax rate in the short run. This incapability results in substantially lower welfare when compared to the case with commitment. Second, given a lack of commitment, the economy with sequential voting yields significantly different macroeconomic and distributional implications from the economy with the optimal policy. In the political economy, the government considers only the interests of the median voter, who is middle class and reluctant to bear larger distortions from a higher tax rate. Therefore, the political economy becomes more efficient but less equal, leading to a worse welfare outcome with the utilitarian criterion.

About the presenter's meeting 

Dr Jang is willing to have a 1:1 meeting with our colleagues and graduate
students on the seminar day. If you would like to meet with the speaker, please
email your time availability to youngsoo.jang@uq.edu.au.