OPTIMAL FISCAL-POLICY - THEORY AND EVIDENCE

This paper presents a theory of optimal public finance in which a succ ession of governments sets welfare-maximizing fiscal policy through ti me. Such a setting allows, for the first time, estimation of stochasti c Euler equations associated with the government's fiscal choice probl em. While there has been theoretical work on the dynamic application o f the theory of optimal taxation, no serious effort has been made to t est this theory with data. This paper deals empirically with the dynam ic application of the theory of optimal taxation in general, and the i ssue of time-consistency in particular. We show that U.S. data do not reject the implications of optimal public finance given by the Euler e quations.