The New Dynamic Public Finance

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Overview

Optimal tax design attempts to resolve a well-known trade-off: namely, that high taxes are bad insofar as they discourage people from working, but good to the degree that, by redistributing wealth, they help insure people against productivity shocks. Until recently, however, economic research on this question either ignored people's uncertainty about their future productivities or imposed strong and unrealistic functional form restrictions on taxes. In response to these problems, the new dynamic public finance was developed to study the design of optimal taxes given only minimal restrictions on the set of possible tax instruments, and on the nature of shocks affecting people in the economy. In this book, Narayana Kocherlakota surveys and discusses this exciting new approach to public finance.

An important book for advanced PhD courses in public finance and macroeconomics, The New Dynamic Public Finance provides a formal connection between the problem of dynamic optimal taxation and dynamic principal-agent contracting theory. This connection means that the properties of solutions to principal-agent problems can be used to determine the properties of optimal tax systems. The book shows that such optimal tax systems necessarily involve asset income taxes, which may depend in sophisticated ways on current and past labor incomes. It also addresses the implications of this new approach for qualitative properties of optimal monetary policy, optimal government debt policy, and optimal bequest taxes. In addition, the book describes computational methods for approximate calculation of optimal taxes, and discusses possible paths for future research.

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What People Are Saying

Bernard Salanie
Much of the theory of public finance was recently transformed when new work incorporated the subtle interaction of dynamics and risk. Narayana Kocherlakota, one of the top contributors to this new literature, has now given us a masterful exposition of its methods and results. This is a must-read for graduate students and researchers alike.
Bernard Salanie, Columbia University
James Poterba
The New Dynamic Public Finance uses the tools of dynamic contract theory to provide interesting and exciting new insights about long-standing topics in tax design. These lectures, by one of the creators of this field, deliver an accessible introduction to key questions and methods, as well a carefully considered analysis of emerging issues and future research opportunities. This volume is sure to become a standard reference.
James Poterba, Massachusetts Institute of Technology, president of the National Bureau of Economic Research
Mikhail Golosov
This is the first major overview of the new dynamic public finance, and the first summary of the subject that can be used as a graduate textbook or research reference. The book covers all the main areas of the literature, from theoretical developments to numerical implementations and practical applications. It should be a required text for any student who takes an advanced public finance course.
Mikhail Golosov, Yale University
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Product Details

  • ISBN-13: 9780691139159
  • Publisher: Princeton University Press
  • Publication date: 7/26/2010
  • Series: Toulouse Lectures in Economics Series
  • Pages: 232
  • Product dimensions: 5.50 (w) x 8.50 (h) x 1.00 (d)

Meet the Author

Narayana R. Kocherlakota is professor of economics at the University of Minnesota.

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Table of Contents

Preface ix
Chapter 1: Introduction 1
1.1 Scope 4
1.2 Lessons 5
1.3 Structure 9
References 11

Chapter 2: The Ramsey Approach and Its Problems 13
2.1 A Simple Model of Government Finance 14
2.2 The Dynamic Ramsey Taxation Problem: Setup 16
2.3 The Dynamic Ramsey Taxation Problem: Solution 19
2.4 Problems with the Ramsey Approach 24
2.5 Summary 28
2.6 Technical Notes 28
References 33

Chapter 3: Basics of Dynamic Social Contracting 34
3.1 Class of Environments 35
3.2 Incentive-Compatibility 39
3.3 Remarks on Incentive-Compatibility 42
3.4 Pareto Optimal Allocations 45
3.5 The Reciprocal Euler Equation 47
3.6 Dynamics of Pareto Optimal Consumption 58
3.7 Long-Run Properties of Pareto Optima 61
3.8 Summary 69
3.9 Technical Notes 71
References 79

Chapter 4: Dynamic Optimal Taxation: Lessons for Macroeconomists 81
4.1 A Nonlinear Tax Problem 82
4.2 Any Tax Equilibrium Is Incentive-Compatible 87
4.3 Building an Optimal Tax System 89
4.4 Properties of the Optimal Tax System 112
4.5 Remarks about the Optimal System 125
4.6 Summary 130
4.7 Technical Notes 131
References 137

Chapter 5: Optimal Intergenerational Taxation 140
5.1 An Intergenerational Tax Problem 141
5.2 Another Reciprocal Euler Equation 150
5.3 Properties of Socially Optimal Allocations 154
5.4 Optimal Bequest Taxation 159
5.5 Summary 164
5.6 Technical Notes 165
References 167

Chapter 6: Quantitative Analysis: Methods and Results 168
6.1 Immortal Agents in an Open Economy 169
6.2 A Closed Overlapping Generations Economy 184
6.3 Summary 198
References 199

Chapter 7: The Way Forward 201
7.1 More Widely Applicable Tax Systems 201
7.2 New Solution Methods 204
7.3 Inputs from the Data 208
7.4 Summary 210
7.5 Technical Notes 211

References 213
Index 215

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