Ramsey Tax Cycles

Abstract

This paper asks whether tax cycles or tax smoothing represents the optimal policy in models without any extrinsic uncertainty. To answer this question, I develop a general framework for studying tax cycles in a large class of models that feature various types of frictions. This framework adds various wedges, resembling tax wedges, to the labour market, to the product market, and to money acquisition into an otherwise frictionless economy, so that it nests a large class of models used for policy analysis. I derive a criterion for this general framework that indicates when cycles are welfare-improving in a frictionless economy, and why frictions make cycles more likely to be optimal. I then calibrate two models with frictions, a labour search model and a monetary model, and show that cycles are welfare-improving under standard preferences. © 2010 The Review of Economic Studies Limited.