ON OPTIMAL TAXATION IN OVERLAPPING GENERATIONS ECONOMIES*

The paper studies optimal taxation in an overlapping generations economy, assuming different degrees of commitment: a) full commitment (second best), b) no commitment, c) partial commitment (next periods ’ taxes are chosen today). It is shown that the second best optimal capital income tax is zero in steady state if the social welfare function is weakly separable across generations. That steady state also obeys the Modified Golden Rule. Third best optimal policy is also solved for (case b) and c)). In case b) the optimal capital income tax is generally not zero, and the steady state is generally not the Modified Golden Rule For special case of preferences (where individuals ’ utility functions are logarithmic), the steady state is the Modified Golden Rule, and furthermore the no commitment tax policy coincides with the tax policy in the full commitment case. In case c) the capital income tax is generally not zero, but the steady state is the Modified Golden Rule. We also derive the class of individual utility functions that are necessary and sufficient for the captial tax being zero at all dates in cases a) and c)