This paper studies the optimal behavior of a democratic government in its use of fiscal policies to redistribute income. First, I characterize the optimal Ramsey allocation in heterogeneous agents’ version of the neoclassical growth model. Second, I show that if I follow the empirical evidence in Storesletten, Telmer, and Yaron (2002) and assume labor income inequality to be countercyclical, fiscal policy is also highly countercyclical, challenging the Chari, Christiano, and Kehoe (1994) result that labor taxes should be smooth over the cycle.
JEL classification: E62, E64
Keywords: optimal taxation, income distribution
The author gratefully acknowledges Albert Marcet, Arantza Gorostiaga, and participants at several seminars for useful comments. The views expressed here are the author’s and not necessarily those of the Federal Reserve Bank of Atlanta or the Federal Reserve System. Any remaining errors are the author’s responsibility.
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