Acemoglu_Ch05 - 5 New Dynamic Public Finance A User's Guide...

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New Dynamic Public Finance: A User’s Guide Mikhail Golosov, MIT and NBER Aleh Tsyvinski, Harvard University and NBER Iván Werning, MIT and NBER 5 1 Introduction New Dynamic Public Finance is a recent literature that extends the static Mirrlees [1971] framework to dynamic settings. 1 The approach addresses a broader set of issues in optimal policy than its static counterpart, while not relying on exogenously speciF ed tax instruments as in the represen- tative-agent Ramsey approach often used in macroeconomics. In this paper we show that this alternative approach can be used to revisit three issues that have been extensively explored within repre- sentative-agent Ramsey setups. We show that this alternative approach delivers insights and results that contrast with those from the Ramsey approach. ±irst, it is optimal to introduce a positive distortion in savings that implicitly discourages savings (Diamond and Mirrlees 1978, Rog- erson 1985, Golosov, Kocherlakota, and Tsyvinski 2003). This contrasts with the Chamley-Judd (Judd 1985, Chamley 1986) result, obtained in Ramsey settings, that capital should go untaxed in the long run. 2 Second, when workers’ skills evolve stochastically due to shocks that are not publicly observable, their labor income tax rates are affected by aggregate shocks: Perfect tax smoothing, as in Ramsey models (Barro 1979, Lucas and Stokey 1983, Judd 1989, Kingston 1991, Zhu 1992, Chari, Christiano, and Kehoe 1994), may not be optimal with uncertain and evolving skills. 3 In contrast, it is optimal to smooth labor distortions when skills are heterogenous but constant or affected by shocks that are publicly observable (Werning 2007). ±inally, the nature of the time- consistency problem is very different from that arising within Ramsey setups. The problem is, essentially, about learning and using acquired information, rather than taxing sunk capital: A benevolent government is tempted to exploit information collected in the past. Indeed, capital is not directly at the root of the problem, in that even if the government
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Golosov, Tsyvinski, and Werning 318 controlled all capital accumulation in the economy—or in an economy without capital—a time-consistency problem arises. 1.1 User’s Guide We call this paper “a user’s guide” because our main goal is to pro- vide the reader with an overview of three implications of the dynamic Mirrlees literature that differ from those of Ramsey’s. Our workhorse model is a two-period economy that allows for aggregate uncertainty regarding government purchases or rates of returns on savings, as well as idiosyncratic uncertainty regarding workers’ productivity. The model is F exible enough to illustrate some key results in the litera- ture. Moreover, its tractability allows us to explore some new issues.
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Acemoglu_Ch05 - 5 New Dynamic Public Finance A User's Guide...

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