Fiscal policy under loose commitment

Due to time-inconsistency or political turnover, policymakers’ promises are not always fulfilled. We analyze an optimal fiscal policy problem where the plans made by the benevolent government are periodically revised. In this loose commitment setting, the properties of labor and capital income taxes are significantly different than under the full-commitment and no-commitment assumptions. Because of the occasional reoptimizations, the average capital income tax is positive even in the long-run. Also, the autocorrelation of taxes is lower, their volatility with respect to output increases and the correlation between capital income taxes and output changes sign. Our method can be used to analyze the plausibility and the importance of commitment in a wide-class of dynamic problems.