New Dynamic Public Finance (Research Summaries‪)‬

Many problems in public finance and macroeconomics, such as the taxation of capital or the provision of Social Security and disability insurance, are dynamic in nature. The individuals who pay taxes or claim benefits are long-lived. The tax and benefit policies in place in one period can affect their behavior in other periods. For example, increasing retirement benefits may affect individuals' behavior and savings in earlier years. The New Dynamic Public Finance literature extends the traditional literature on optimal income tax and optimal program design, much of which focused on settings in which individuals made decisions in a single period, to focus on such dynamic settings. (1) While the same efficiency-equity tradeoffs that apply in single-period settings also arise in dynamic settings, there are additional tradeoffs between providing insurance and preserving incentives. When individuals live for many periods, they may experience both favorable and unfavorable "shocks" as they age: unexpected increases in their wages, or the early onset of a disability, for example. Public policy can provide insurance against adverse shocks, but it may do so at some cost in incentives. Much of the research in New Dynamic Public Finance is directed at understanding how one can design social insurance or redistribution systems that achieve distributional objectives while ensuring necessary incentives to provide effort or work throughout individuals' lives.