DP6577 | Intertemporal Distortions in the Second Best

Publication Date

23/11/2007

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Abstract

We consider a very general class of public finance problems that encompasses the Ramsey model of optimal taxation as well as economies with limited commitment, private information, and political economy frictions, and allows for incomplete markets. We identify a sufficient condition to rule out permanent intertemporal distortions at the optimum. If there exists an admissible allocation that converges to the first best steady state, then all intertemporal distortions are temporary in the second best. We analyze a series of applications to illustrate the significance of this result.