Nelson Hall 4108, Box 8110
Raleigh NC, 27695
North Carolina State University
Legislative and implementation lags inherent in the political process often allow private agents to receive news about their future tax rates, giving agents "tax foresight." This paper investigates the effects of tax foresight on monetary policy under various assumptions about the information set of the monetary authority. We examine the welfare effects of tax foresight and how such foresight affects the monetary authority's ability to implement its policy. Our model is a simple version of the dynamic sticky price models extended to include possible foresight about changes in distortionary taxes. We find that the optimal response of the interest rate to anticipated tax changes can be qualitatively different from the response under a simple Taylor rule and that welfare rankings under foresight depend crucially on the welfare measure. In addition, identification issues present when the monetary authority has partial information about the state of the economy make it impossible for the monetary authority to recover the correct structural disturbances from its observable variables. This, in turn, causes the monetary authority to induce history dependence in endogenous variables and worsen the welfare of private agents.