Optimal fiscal policy with recursive preferences

I study the implications of recursive utility for the design of optimal fiscal policy. I find that the standard policy prescriptions of the dynamic Ramsey literature are dramatically altered. Labor tax volatility is optimal and can be quantitatively substantial. Furthermore, labor taxes are countercyclical, display persistence independent of the stochastic properties of exogenous shocks and increase on average over time. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex ante capital subsidy. Ignoring the distinction between smoothing over time and smoothing over states is not an innocuous assumption for optimal policy.