Abstract
This paper makes an original contribution to the literature of optimal taxation by introducing Ramseytaxation to the Solow-Uzawa growth model to examine genuine dynamic interdependence between growth andoptimal taxation. We introduce a public sector to the Uzawa two-sector growth model. The public sector suppliespublic goods and services. The government financially supports by the public sector by collecting taxes on thehousehold’s wage income and wealth income under the assumption that the utility level is maximized. We derivethe optimal taxation rule and construct the dynamics of the national economy. The model studies a nonlineardynamics between national and sectoral growth, economic structural change, wealth/capital accumulation, andoptimal tax rates in perfect competitive markets with the government intervention. The model has a uniquestable equilibrium point with the chosen parameter values. We carry out comparative dynamic analysis toanalyze effects of exogenous changes in a few parameters on the transitional process and long-term economicstructure of the economic dynamics.
Highlights
Since the pioneering work on optimal taxation by Ramsey (1927), how to formally analyze optimal taxation in different economies under different institutions has caused great attention from economists
We address issues related to optimal taxation in neoclassical growth theory
We introduced the public sector to the Uzawa two-sector growth model
Summary
Since the pioneering work on optimal taxation by Ramsey (1927), how to formally analyze optimal taxation in different economies under different institutions has caused great attention from economists. The model studies a nonlinear dynamic interdependence between national and sectoral growth, economic structural change, wealth/capital accumulation, and optimal tax rates in perfect competitive markets with the government intervention. In almost all the recent literature of theoretical economics on dynamic interdependence of economic growth and optimal taxation economists apply either the OLG modeling framework in discrete time or the Ramsey framework in continuous time. Deviating from these theoretical approaches to studying household behavior, this study applies Zhang’s approach to household behavior to analyze problems well-addressed in optimal taxation theory.
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