Dynamic Optimal Taxation with Private Information

We study dynamic optimal taxation in a class of economies with private information. Optimal allocations in these environments are complicated and history-dependent. Yet, we show that they can be implemented as competitive equilibria in market economies supplemented with "simple" tax systems. The market structure in these economies is similar to that in Bewley (1986); agents supply labour and trade risk-free claims to future consumption, subject to a budget constraint and a debt limit. Optimal taxes are conditioned only on two observable characteristics-an agent's accumulated stock of claims, or wealth, and her current labour income. We show that optimal taxes are generally non-linear and non-separable in these variables and relate the structure of marginal wealth and income taxation to the properties of agent preferences. Copyright 2006 The Review of Economic Studies Limited.