DP6577 Intertemporal Distortions in the Second Best

Author(s): Stefania Albanesi, Roc Armenter
Publication Date: November 2007
Keyword(s): Intertemporal Distortions, Optimal Dynamic Taxation
JEL(s): E6, H21
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=6577

We consider a very general class of public finance problems that encompasses the Ramsey model of optimal taxation as well as economies with limited commitment, private information, and political economy frictions, and allows for incomplete markets. We identify a sufficient condition to rule out permanent intertemporal distortions at the optimum. If there exists an admissible allocation that converges to the first best steady state, then all intertemporal distortions are temporary in the second best. We analyze a series of applications to illustrate the significance of this result.