Markov-perfect optimal taxation

In this paper we study optimal taxation in a dynamic game played by a sequence of governments and the private sector. We focus on the Markov-perfect equilibrium of this game under two different assumptions on the extent of government's intra-period commitment, which in turn define two within-period timings of actions. Our results show that the extent of government's intra-period commitment has important quantitative implications for policies, welfare, and macroeconomic variables, and consequently that it must be explicitly stated as one of the givens of the economy, alongside preferences, markets and technology. We see this as an important result, since most of the previous literature on Markovian optimal taxation has assumed, either interchangeably or unnoticeably, different degrees of government's intra-period commitment. (c) 2005 Elsevier Inc. All rights reserved.