Tax Rates, Deficits, and Intertemporal Efficiency

Abstract

This article contains the derivation of a compact elasticity formula for the efficient taxation of labor income in an intertemporal setting. The question of whether or not efficient public financial policy will involve constant tax rates over time is addressed by reference to this formula under various specifications of the economic environment. A specific set of assumptions sufficient to generate tax constancy consists of (1) preferences of the isoelastic marginal utility class and (2) public debt indexation to aggregate consumption levels. In this instance, the government would find it optimal to run deficits—holding tax rates constant—when either public expenditure levels are high or when tax base levels are low.