A popular theory of optimal tax policies suggests that tax rates should follow a random walk. This paper extends the existing empirical literature in three ways. First, the impact on the marginal utility of consumption when the government chooses a tax plan to smooth the distorting impact of taxes is considered. Second, exogenous changes in the real rate of interest are incorporated into the government's optimal tax plan. Finally, the tax elasticity of output is not constant over time. Allowing for these changes, there is evidence that the government discounts the future, attempts to smooth the distorting impact of taxes on the marginal utility of consumption, and that the tax elasticity of output moves predictably during wars.
© 1993 MIT Press
Hess, Gregory. "A Test of the Theory of Optimal Taxation for the United States: 1870-1989." The Review of Economics and Statistics, 75 (1993): 712-716.