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This paper examines the optimal time path of the tax rate,in a model where an increasing ratio of government debt to GDP is projected in the absence of policy changes. Tax policy changes have feedback effects, as a result of incentives and other endogenous influences which impose constraints on the efficacy of those policies. Emphasis is given to the importance of uncertainty in devising an optimal policy. A welfare function is maximised, allowing for a range of variables, including the excess burden of taxation and a desired debt ratio.
We are grateful to Bob Buckle, Andrew Coleman, Arthur Grimes, Michael Johnston, Suzy Morrissey and Tugrul Vehbi for their helpful comments on an earlier draft of this paper.
The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the author(s). They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate.
Table of Contents
- Executive Summary
- 1 Introduction
- 2 The Projection Model
- 3 An Evaluation Function
- 4 Optimal Tax Rates in The Deterministic Model
- 4.1 Tax Smoothing
- 5 The Stochastic Model
- 5.2 Decision Making with Random Outcomes
- 6 Optimal Tax Rates in The Stochastic Model
- 7 Conclusions
- Appendix A: Formal Statement of The Model
- Appendix B: Redistribution