Using a pure-exchange overlapping generations model, characterized with tax evasion and information asymmetry between the government (the social planner) and the financial intermediaries, the author discusses the optimal tax and seigniorage plans, derived from the welfare maximizing objective of the social planner. It is observed that irrespective of whether the economy is characterized by tax evasion or asymmetric information, a benevolent social planner maximizing welfare and simultaneously financing the budget constraint, should optimally rely on explicit, rather than implicit taxation.
This article explores the relative importance of explicit and implicit taxation, in the
presence of tax evasion and asymmetric information. Using a pure-exchange overlapping
generations model, characterized by tax evasion and information asymmetry between the
government (the social planner) and the financial intermediaries, we seek for the optimal
tax and seigniorage plans, derived from the welfare maximizing objective of the social
planner. In the economic framework, discussed here the demand for money is a forceddemand,
since banks are obligated to hold a ‘high’ fraction of their deposits as cash reserves.
Money is assumed to have no other role. In such an environment, the size of the reserve
requirement decides the size of the seigniorage tax base, while the implicit tax rate is
the money growth rate or the rate of inflation.
The motivation to look into this issue of optimal mix of explicit and implicit taxation,
is simply to understand when would a government prefer the former over the latter, based
on a welfare maximizing criterion. The social planner is assumed to have access to income
taxation and can choose the size of the reserve requirement and money growth rate, and
hence, seigniorage, to maximize the welfare of agents subject to its budget constraint. |
