Time-consistent fiscal policy and heterogeneous agents

Abstract

This paper characterizes the time-consistency properties of the set of Pareto efficient (or second best) fiscal policies, in a two-class, stochastic economy similar to that in [Judd, K.L., 1985, Redistributive taxation in a simple perfect foresight model, Journal of Public Economics 28, 59–83]. The key finding is that the continuation of any Pareto efficient policy is always Pareto efficient. Hence, to require any policy revision to be approved by unanimity safeguards the time consistency of efficient fiscal policy. I also show that any Pareto efficient policy from a timeless perspective can be rendered time consistent by a policymaker whose objective function is given by a utilitarian social welfare function with precise welfare weights. These results link the policymaker's equity considerations with the credibility of efficient fiscal policy.