Optimal Fiscal Policy with Epstein–Zin Preferences and Utility-Enhancing Government Services: Lessons from Bulgaria (1999–2016)

Abstract

ABSTRACT This article compares and contrasts exogenous (observed) and optimal fiscal policy in an economy with Epstein–Zin (1989, 1991) preferences, with consumption tax, and with a common income tax, using a dynamic general-equilibrium model, calibrated for Bulgarian data (1999–2016). The focus is on the relative importance of consumption versus income taxation, as well as on the provision of utility-enhancing public services. The main findings are: (i) The optimal steady-state income tax rate is zero. (ii) The benevolent Ramsey planner sets optimally the utility-enhancing public services, which are now 25% higher. (iii) The optimal steady-state consumption tax is approximately 50% higher.