We now augment the Ramsey model, incorporating a government.

It taxes households with a lump-sum tax $T_{t}$ and uses these proceedings to buy goods $G_{t}.$ Assumption RG 1 We assume that government purchases do not affect the utility derived from private consumption. This can be because:

  • The government devotes revenue $T_{t}$ to an activity households do not derive utility from
  • Households utility equals the sum of private consumption and goods provided by the government.

Assumption RG 2 Another assumption is that the government uses all taxes to fund exclusively its purchases $G_{t}.$ Therefore, the government does not save: no public investment.

Finally, the government runs a balanced budget in each and every period: $G_{t} = T_{t}.$i1

This extension does not modify the behaviour of firms. In fact, taxes affect only households through their budget constraint.

  1. Romer, in Advanced Macroeconomics chapter 11 shows that in the Ramsey model the choice between taxes and deficit does not impact the relevant variables. ↩︎