Time-consistent consumption taxation

We characterise optimal fiscal policies in a Real Business Cycle model when the government has access to consumption taxation but cannot credibly commit to future policies. Contrary to the case where only labour and capital income are taxed, the optimal time-consistent policies are remarkably similar to their Ramsey counterparts, as long as the capital income tax causes some distortion within the period. The welfare gains from commitment are negligible, while they are substantial without consumption taxation. Further, the welfare gains from taxing consumption are much higher without commitment. These results suggest that the policymaker’s ability to commit is of secondary importance if consumption is taxed optimally.