Optimal Tax Policy With Variable Rate Of Time Preference

In the Neoclassical growth model, with constant rate of time preference, consumer has a stable preference system, in which the beneficent government chooses the optimal tax rate to be proportional to the rate of time preference with the assumption of log utility and AK production function. When the model is modified to include a variable rate of time preference and lack in commitment ability, the Markov perfect equilibrium prefers a constant optimal tax rate nevertheless, being proportional to the constant effective rate of time preference. Short-run impatience of consumers results in the increment of tax rate, and consequentially the decline of capital accumulation rate. To maximize the social welfare, the government will take into consider two effects of taxation when making tax policies. On the one hand, the imposition of tax will beget decline in the rate of return of capital, which is to retard the economic growth. On the other hand, the government will employ the revenue of tax to public expenditures, which is to add to the present utility of consumers at the expense of growth rate. The optimal tax policy is designed to achieve a trade-off between the two effects in the long run. When commitment ability is involved in the framework, we discover the correlation between the extent of commitment ability and the design of tax policy as well as the corresponding growth rate. The more consumers are committed to follow the prescribed choices, the more quickly capital accumulates. Because certain institutional mechanisms and public policies are supposed to strengthen consumers' commitment ability, the economic growth can be propelled by employing those measures. In addition, the effects that population growth and consistent conjecture have on tax policy are also obtained in this paper, and the transitional dynamics of consumption and tax policy are characterized for isoelastic utility.