I study the optimal taxation of labor and capital in a dynamic economy subject to government expenditure and technology shocks. Unlike representative-agent Ramsey models, workers are heterogenous and lump-sum taxation is not ruled out. I consider two tax scenarios: (a) linear taxation, with a lump-sum intercept and (b) nonlinear-Mirrleesian taxation. When taxes are linear, I derive a partial-equivalence result with Ramsey settings that provides a reinterpretation of such analyses. I find conditions for perfect tax smoothing of labor-income taxes and zero capital taxation. Implications that contrast with Ramsey are derived for public-debt management, for the nature of the time-inconsistency problem and for the viability of replicating complete markets without state-contingent bonds. Shifts in the distribution of skills provide a novel source for variations in tax rates. For the nonlinear tax scenario, I show that taxation based on income averages is optimal. I.

This paper argues that a risk-averse worker's after-tax reservation wage encodes all the relevant information about her welfare. This insight leads to a novel test for the optimality of unemployment insurance based on the responsiveness of reservation wages to unemployment benefits. Some existing estimates imply significant gains to raising the current level of unemployment benefits in the United States but highlight the need for more research on the determinants of reservation wages. Our approach complements those based on Baily's [Journal of Public Economics, X (1978), 379–402] test.

We consider a dynamic Mirrlees economy in a life-cycle context and study the optimal insurance arrangement. Individual productivity evolves as a Markov process and is private information. We use a first-order approach in discrete and continuous time and obtain novel theoretical and numerical results. Our main contribution is a formula describing the dynamics for the labour-income tax rate. When productivity is an AR(1) our formula resembles an AR(1) with a trend where: (i) the auto-regressive coefficient equals that of productivity; (ii) the trend term equals the covariance productivity with consumption growth divided by the Frisch elasticity of labour; and (iii) the innovations in the tax rate are the negative of consumption growth. The last property implies a form of short-run regressivity. Our simulations illustrate these results and deliver some novel insights. The average labour tax rises from 0% to 37% over 40 years, whereas the average tax on savings falls from 12% to 0% at retirement. We compare the second best solution to simple history-independent tax systems, calibrated to mimic these average tax rates. We find that age-dependent taxes capture a sizable fraction of the welfare gains. In this way, our theoretical results provide insights into simple tax systems.

We study efficient non-linear taxation of labour and capital in a dynamic Mirrleesian model incorporating political economy constraints. Policies are chosen sequentially over time, without commitment. Our main result is that the marginal tax on capital income is progressive, in the sense that richer agents face higher marginal tax rates.