OPTIMAL TAXATION OVER TIME AND THE TIME INCONSISTENCY PROBLEM

This dissertation research studies two related questions concerning dynamically optimal fiscal policies: the structure of optimal taxation over time and the potential time inconsistency of such taxation. Chapter One is concerned with the optimal pattern of taxation over time, given that the government must raise revenue to finance a specified time path of government expenditures. In a simple economy without capital, we first derive a general formula of optimal taxation and then give an intuitive interpretation. In contrast with some previous studies, e.g., Barro (JPE, 1979), it turns out that the optimal taxation structure depends, among other things, on individuals' preferences and productivities. Only under some special conditions does optimal taxation have a uniform structure over time. It is, however, typically desirable for the government to smooth tax rates by issuing public debt.;Chapter three is an exploratory study of the public debt in the U.S. from 1916 to 1982. First, a brief history of the U.S. public debt management is provided. Second, a time series data of the average maturity of marketable interest-bearing debt is constructed. Finally, the behavior of this average maturity series is analyzed and compared with the predictions of the theoretical analyses in the first two chapters.;Lucas and Stokey (JME, 1983) show that optimal taxation policy is time inconsistent in general. However, they demonstrate that with a rich enough menu of assets, a particular debt structure will make optimal policy time consistent. Chapter two provides an economic explanation of these results. First, we know that optimal taxation formulae take into account the government's ability to influence market prices of assets. Second, in the absence of precommitment, time inconsistency occurs because the government can lower the present value of its expenditures and thus reduce the distortion from taxation by choosing to postpone taxation. Third, this approach indicates that a time inconsistent policy inflicts capital losses. Finally, a particular structure of public debt can lead the government to 'internalize' such potential capital losses and, hence, yields a time consistent policy.