Three essays on Public Economics and heterogeneity.

Abstract

This thesis presents a collection of essays about Public Economics and individual heterogeneity. The essays are motivated by two different subjects. The first subject refers to the relation between economic outcomes and majority voting in a democratic regime. More specifically, the outcome regarding redistributive labor income taxes is analyzed when heterogeneous individuals vote, once and for all, over an infinite sequence of taxes. The second subject refers to time consistency problems in Public Economics. Issues about optimal fiscal policy are considered in an environment where different individuals hold distinct information about (sequential) action performed by the government. This friction prevents the standard punishment mechanism that enforces good policy outcomes or, alternatively, inhibits the occurrence of time consistency problems. The best equilibrium outcome is then analyzed in this new situation. Chapters 2 focus on the first subject. Moreover, the chapter explores the relationship between changes in labor income inequality and movements in labor taxes over the last decades in the US. In order to do so, this relation is modeled through a political economy channel by developing a median voter result over sequence of taxes. We consider an infinite horizon economy in which agents are heterogeneous with respect to both initial wealth and labor skills. We study indirect preferences over redistributive fiscal policies - sequences of affine taxes on and capital income - that can be supported as a competitive equilibrium. The paper assumes balanced growth preferences and full commitment. The first result is the following: if initial capital holdings are an affine function of skills, then the best fiscal policy for the agent with the median labor skill is preferred to any other policy by at least half of the individuals in the economy. The second result provides the characterization of the most preferred tax sequence by the median agent: marginal taxes on labor depend directly on the absolute value of the distance between the median and the mean value of the skill distribution. We extend the above results to an economy in which the distribution of skills evolves stochastically over time. A temporary increase in inequality could imply either higher or lower labor taxes, depending on the sign of the correlation between inequality and aggregate labor. The calibrated model does a good job on fitting both the increasing trend and the levels of labor taxes in the last decades, and also on matching some short run co-movements. Chapter 3 generalizes the median voter theorem developed in chapter 2 to a situation where there is no commitment or, alternatively, voting is sequential over time. More specifically, the same equilibrium definition as in Bernheim and Slavov (2008) is adopted. Chapter 4 deals with optimal fiscal policy when the government takes actions sequentially over time and cannot commit to a pre-specified plan of actions. These features potentially generate what is known in the literature as time consistency problems. Although these problems play an important role in public policy, game theoretical models in macroeconomics seem to indicate the opposite. Due to the complexity of this kind of models, it is commonly assumed that information is complete and perfect. In turn, this assumption becomes the key element that allows agents to coordinate perfectly to punish the government if it does not do what private agents want. As a result, a wide range of feasible payoffs can be sustained as equilibrium, including the best payoff under commitment. Since this approach is widely used for normative purposes a natural question emerges: are the above results robust to small variations in information? This paper analyzes an investment taxation problem in an economy with incomplete information. Specifically, we study an environment with the following main characteristics: 1) the aggregate productivity (fundamental) is stochastic, 2) only the government observes it and; 3) every agent privately receives a noisy signal about the fundamental. The first characteristic implies that the best policy (tax on investment) with commitment is state contingent. The second and third characteristics make the information incomplete. In particular, agents have different information sets, and therefore different beliefs, about the true state of the economy. As a result, independently of the accuracy of the signal, incomplete information reduces the set of equilibrium payoffs. First, we show that any policy that depends solely on the fundamental cannot be an equilibrium. Second, the best equilibrium policy is independent of the fundamental. Finally, for any discount factor strictly smaller than one and for any size of the noise, the best equilibrium is inefficient.