Optimal Taxation with Endogenous Insurance Markets

Mikhail Golosov, Aleh Tsyvinski

NBER Working Paper No. 11185
Issued in March 2005
NBER Program(s):   EFG   PE

We study optimal tax policy in a dynamic private information economy with endogenous private markets. We characterize efficient allocations and competitive equilibria. A standard assumption in the literature is that trades are observable by all agents. We show that in such an environment the competitive equilibrium is efficient. The only effect of government interventions is crowding out of private insurance. We then relax the assumption of observability of consumption and consider an environment with unobservable trades in competitive markets. We show that efficient allocations have the property that the marginal product of capital is different from the market interest rate associated with unobservable trades. In any competitive equilibrium without taxation, the marginal product of capital and the market interest rate are equated, so that competitive equilibria are not efficient. Taxation of capital income can be welfare-improving because such taxation introduces a wedge between market interest rates and the marginal product of capital and allows agents to obtain better insurance in private markets. Finally, we use plausibly calibrated numerical examples to compute optimal taxes and welfare gains and compare results to an economy with a restricted set of tax instruments, and to an economy with observable trades.

download in pdf format
   (680 K)

email paper

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w11185

Published: Mikhail Golosov, 2007. "Optimal Taxation With Endogenous Insurance Markets," The Quarterly Journal of Economics, MIT Press, vol. 122(2), pages 487-534, 05. citation courtesy of

Users who downloaded this paper also downloaded* these:
Einav, Finkelstein, and Levin w15241 Beyond Testing: Empirical Models of Insurance Markets
Einav and Finkelstein w16723 Selection in Insurance Markets: Theory and Empirics in Pictures
Froot w10184 Risk Management, Capital Budgeting and Capital Structure Policy for Insurers and Reinsurers
Viscusi and Born w12348 The Catastrophic Effects of Natural Disasters on Insurance Markets
Bobashev, Cropper, Epstein, Goedecke, Hutton, and Over w17195 Policy Response to Pandemic Influenza: The Value of Collective Action
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us