An Equilibrium Analysis of Fiscal Policy with Uncertainty and Incomplete Markets.

Insurance aspects of tax policies are studied in a simple intertemporal general equilibrium model in which agents are uncertain about both the future wage rates and the rate of return on capital. Taxation and lump-sum subsidy policies generally reduce employment, output, and the capital stock but, nonetheless, they can be structured to provide Pareto improvements on the incomplete market equilibrium. These policies provide insurance against individual shocks, not aggregate shocks. Examples of welfare maximizing tax schemes are provided using a simple computable general equilibrium model. Copyright 1993 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.