Revised May 1, 2004
We study dynamic optimal taxation in a class of economies with private information. Constrained optimal allocations in these environments are complicated and history-dependent. Yet, we show that they can be implemented as competitive equilibria in market economies supplemented with simple tax systems. The market structure in these economies is similar to that in Bewley (1986): agents supply labor and trade risk-free claims to future consumption, subject to a budget constraint and a debt limit. Optimal taxes are conditioned only on two observable characteristics—an agent’s accumulated stock of claims, or wealth, and her current labour income—and they are not additively separable in these variables. The marginal wealth tax is decreasing in labour income and its expected value is generally positive. The marginal labour income tax is decreasing in wealth.
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