Ramsey optimal taxation with wage rigidities

Abstract

This thesis aims to assess the impact of downward wage rigidities on optimal tax- ation. We study a dynamic general equilibrium neoclassical growth model for a one sector, cashless stochastic closed economy with an in nitely lived representative house- hold, a representative rm with a constant returns to scale technology, a government deciding how to nance its exogenous expenditures without access to lump sum taxes, and competitive markets. We conclude that the optimal labor income tax exhibits both a reactive and a precautionary nature. Regarding the reactive nature, when the wage rigidity is binding, labor taxes increase since it is possible to raise revenue without ad- ditional distortions. On the precautionary side, the expectation of a future constraint lowers labor taxes, which, in turn, decreases the wage that clears the labor market, thus loosening future constraints. In the nominal small open economy with downwardly rigid nominal wages and exogenous nominal exchange rates, we show that the same conclu- sions apply. Additionally, it is possible to use consumption taxes in such a way that the optimal capital control tax is zero for a broad family of instantaneous utility functions. Finally, we introduce a consumption tax that discriminates between the good produced in the domestic economy and the good produced abroad to show that downward wage rigidities and exogenous exchange rates are irrelevant if the correct policy is used.

Date of Award	18 Jul 2017
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Catarina Reis (Supervisor)