Welfare and optimum dynamic taxation of consumption and income

This paper estimates that the US could attain large welfare gains by implem enting an optimal Ramsey tax policy that taxes consumption and income. It i s also found that the welfare implications associated with taxing consumpti on are quantitatively more important than those associated with dynamically taxing income. Indeed, replacing income taxes with a constant consumption tax leads to a welfare gain that is only slightly lower than that attained by a dynamic policy that taxes consumption and income. In computing these w elfare gains, careful attention is given to the dynamic path of tax rates a nd the transitional dynamics associated with how the economy responds to a new tax policy. (C) 2000 Elsevier Science S.A. All rights reserved.