A two-period endowment economy as we studied in class has consumers with identical preferences and the consumption good is non storable. Suppose that there is a benevolent government (i.e. a government that seeks to maximize the welfare of consumers) that imposes lump-sum taxes and make lump-sum transfers. (Recall, taxes can be negative, in which case they are called transfers.) The government must satisfy its present-value budget constraint

where T _t denotes taxes (T _t > 0) or transfers (T _t 1 is much larger than the period 2 one, y ₂ , but that the consumer prefers similar consumption levels in both periods. A politician claims that the welfare of consumers can be improved in this situation by imposing a tax-transfer scheme such that T ₁ > 0 and T ₂

T+ T 1+r =0