| Abstract: |
We study optimal tax policy in a dynamic private information economy with
endogenous private markets. We characterize efficient allocations and
competitive equilibria. A standard assumption in the literature is that trades
are observable by all agents. We show that in such an environment the
competitive equilibrium is efficient. The only effect of government
interventions is crowding out of private insurance. We then relax the
assumption of observability of consumption and consider an environment with
unobservable trades in competitive markets. We show that efficient allocations
have the property that the marginal product of capital is different from the
market interest rate associated with unobservable trades. In any competitive
equilibrium without taxation, the marginal product of capital and the market
interest rate are equated, so that competitive equilibria are not efficient.
Taxation of capital income can be welfare-improving because such taxation
introduces a wedge between market interest rates and the marginal product of
capital and allows agents to obtain better insurance in private markets.
Finally, we use plausibly calibrated numerical examples to compute optimal
taxes and welfare gains and compare results to an economy with a restricted
set of tax instruments, and to an economy with observable trades. |