OPTIMAL FISCAL-POLICY IN A BUSINESS-CYCLE MODEL

This paper develops the quantitative implications of optimal fiscal po licy in a business cycle model. In a stationary equilibrium, the ex an te tax rate on capital income is approximately zero. There is an equiv alence class of ex post capital income tax rates and bond policies tha t support a given allocation. Within this class, the optimal ex post c apital tax rates can range from close to independently and identically distributed to close to a random walk. The tax rate on labor income f luctuates very little and inherits the persistence properties of the e xogenous shocks; thus there is no presumption that optimal labor tax r ates follow a random walk. Most of the welfare gains realized by switc hing from a tax system like that of the United States to the Ramsey sy stem come from an initial period of high taxation on capital income.