Time-consistent fiscal policy under heterogeneity: Conflicting or common interests?

Abstract

This paper studies the aggregate and distributional implications of Markov-perfect tax-spending policy in a neoclassical growth model with capitalists and workers. Focusing on the long run, our main …ndings are: (i) it is optimal for a benevolent government, which cares equally about its citizens, to tax capital heavily and to subsidise labour; (ii) a Pareto improving means to reduce inefficiently high cap- ital taxation under discretion is for the government to place greater weight on the welfare of capitalists; (iii) capitalists and workers inter- ests, regarding the optimal amount of "capitalist bias", are not aligned implying a trade-off between efficiency and equity.Optimal fiscal policy, Markov-perfect equilibrium, heterogenous agents