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Ramsey Asset Taxation Under Asymmetric Information

Gottardi, P; Pavoni, N; (2008) Ramsey Asset Taxation Under Asymmetric Information. UNSPECIFIED

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This paper aim at creating a bridge between the classical Ramsey capital taxation literature and the more recent Mirrleesian approach to optimal wealth or asset taxation in general equilibrium. We consider environments with competitive markets for insurance in the presence of asymmetric information of the moral hazard (hidden effort) type. Insurance firms are able to observe the realization of the idiosyncratic shocks affecting agents' income but cannot observe the effort level undertaken by agents, which affects the likelihood of the individual shocks, nor the trades made by agents in the market; the contracts traded in the insurance markets are thus non exclusive. In such environments we may still have state contingent claims been traded (e.g. Arrow securities), provided only there is a different price for buying and selling such claims (i.e. a bid ask spread is allowed), and prices are otherwise linear in trades. Markets can hence potentially provide insurance and we consider the case where a complete set of Arrow securities contingent on each individual shocks are available for trade. In this set-up the market outcome is typically inefficient, even when the incentive constraints are taken into account. We study the optimal taxation in this environment. The limited information over agents' trades - in particular the anonymity of trades in the markets implies the government can only resort to linear taxes on asset trades (purchases). The government can also impose lump sum taxes or transfers. The specific form of these taxes depends in turn on the information available over agents' income shock realizations. In this regard we consider both the case where the government has the same information as insurance firms have and the case where the government can only impose deterministic lump-sum taxes. In all cases, taxes on asset trades are linear and - unlike Kocherlakota (2005) - they cannot be contingent on the ex-post realization of the individual shock. This is in accordance to the anonymity of the insurance and credit markets. The main finding is that tax on capital is typically positive and that the second best can be achieved if and only if agent's joint deviations are irrelevant (i.e., if and only if the so called 'first order approach' is valid). The idea is simple. Ex-ante taxes can be used to make the agent indifferent between not deviating and deviating only in the level of his trades (not effort). The lump-sum taxes are designed so as to induce the efficient allocation where the agent is indifferent between at least two effort levels (with no deviation in trades).

Type: Other
Title: Ramsey Asset Taxation Under Asymmetric Information
Keywords: Optimal Taxation, Moral Hazard, Hidden Trades
UCL classification: UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > Faculty of SandHS > Dept of Economics
URI: http://discovery.ucl.ac.uk/id/eprint/178551
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