OPTIMAL TAX RULES IN A DYNAMIC-STOCHASTIC ECONOMY WITH CAPITAL

This paper investigates optimal taxation in a disaggregated neoclassic al growth model. Optimal tax rules for a government, which must financ e an exogenous stochastic stream of spending, are investigated. Many l ocally optimal rules are found and two principles, which provide usefu l guidance into interpreting them, are described. These principles sta te that high steady state investment and small investment volatility a re desired. A persistent income tax policy suggested by Judd (1989) is found to be among the best policies, Although some policies with comp licated dynamic implications have similar welfare levels, because of i ts simplicity, the persistent income tax rule is recommended.