Optimal scal policy and the (lack of) time inconsistency problem  Marina Azzimonti y University of Iowa Pierre-Daniel Sarte Federal Reserve Bank of Richmond Jorge Soares George Washington University January 2005 Abstract Much work has recently been devoted to the study of optimal scal policy in environments where the government cannot commit to future policy actions. To this point, and without exception, this literature has abstracted either from government debt, capital, or both, and a working assumption at the outset is that the solutions with and without commitment do not coincide. In contrast, we show that once private capital and government debt are simultaneously allowed in a representative agent framework, the assumed time inconsistency of Ramsey optimal tax rates is unfounded. More specically, we show that the high initial capital levy and zero steady state tax on capital that emerge as optimal with full government commitment also emerge as a time consistent Markov perfect equilibrium. Furthermore, this result holds either in nite or innite horizon, and irrespective of whether the time path of government spending is determined exogenously or endogenously within the model. Finally, we discuss departures from the conventional framework that reintroduce time inconsistency as a policy concern, despite the coexistence of private capital and government debt.  PRELIMINARY AND INCOMPLETE. We thank Huberto Ennis, Bob King, Leo Martinez, Alex Wolman, Per Krusell, Thomas Renstrom and the participats of the 2005 Midwest Macroeconomic Conference for valuable discus- sions. y Corresponding author: Tel.:+1-319-335-0914; E-mail address: marina-azzimonti@uiowa.edu. 1