A general theory of tax-smoothing

Abstract:

This paper organizes, reinterprets and extends the dynamic theory of optimal fiscal policy with a representative agent by  using  a generalized version of recursive preferences. I allow markets to be   complete or incomplete and study a   policymaker that   acts under   commitment or discretion. I  highlight the underlying common  principles that hide in each particular economic environment. The resulting theories are  interpreted through  the excess burden of taxation, a multiplier, whose  evolution  gives rise to different  notions  of ``tax-smoothing.''  Variants of  a  law of motion in terms of the inverse excess burden  emerge in each environment when we allow for richer asset pricing implications through recursive preferences.The basic policy prescription is simple and  intuitive and revolves around interest rate manipulation: issue new  debt and tax more in the future if this can lead to lower interest rates today.