Abstract
We study time-consistent labour and capital income linear taxation using an infinite-horizon overlapping-generations model of a small open economy. Individuals have different productivities and the government intervenes for purely redistributive purposes. The study of time-consistent taxation requires the introduction of borrowing restrictions in the economy. We characterize the time-consistent solution and consider alternative solutions based on a simple tax rule. We demonstrate the existence and the uniqueness of the time-consistent solution using a log-linear utility function. We provide numerical comparisons between time-consistent and time-inconsistent linear taxation: the importance of being able to make commitment decreases when the differences between individuals increase. Copyright 2002, Oxford University Press.
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