Balanced-budget income taxes and aggregate stability in a small open economy (original) (raw)
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A Note on Balanced-Budget Income Taxes and Aggregate (In)Stability in Multi-Sector Economies
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We examine the impact of balanced-budget labor income taxes on the existence of expectation-driven business cycles in a two-sector version of the Schmitt-Grohé and Uribe (SGU) [(1997) Journal of Political Economy 105, 976–1000] model with constant government expenditures and counter-cyclical taxes. Our results show that the destabilizing impact of labor income taxes strongly depends on the capital intensity difference across sectors. Local indeterminacy is indeed more likely when the consumption good sector is capital intensive, as the minimal tax rate decreases, and less likely when the investment good sector is capital intensive, as the minimal tax rate increases. The implication of this result can be quantitatively significant. Indeed, when compared to SGU, local indeterminacy can be either completely ruled out for all OECD countries when the investment good is sufficiently capital intensive or drastically improved, delivering indeterminacy for a larger set of OECD countries, if ...
Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes
The Economic Journal, 2007
It is known that in a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise due to endogenous labour income tax rates. This article shows that when the government finances its expenditures via an endogenous consumption tax instead, a steady state is always saddle-path stable. Consequently, combining income taxes with consumption taxes makes the ranges of indeterminacy shrink, thus reducing the possibility of aggregate instability. From a policy perspective, the results provide an additional argument in favour of consumption taxes in place of capital taxes. * I am grateful to Jang-Ting Guo, Andrew Scott, Joseph Zeira and two anonymous referees for their comments and suggestions on improving this article. For various comments, I also thank seminar participants at the ECB,
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This paper examines the stability of a small open economy under alternative income taxation rules. Using a one-sector real business cycle model with external increasing returns, we show that if the income taxation is progressive, the small open economy will not generate equilibrium indeterminacy, but it exhibits a diverging behavior if the degree of external increasing returns is su¢ciently large. In this case, a progressive tax schedule on the factor income may recover saddle stability. We also reveal that if the taxation on the interest income from …nancial assets is regressive, then the small open economy may exhibit equilibrium indeterminacy. In this situation, progressive taxation is also useful for eliminating sunspot-driven ‡uctuations.
Balanced-budget rules and macroeconomic (in)stability
Journal of Economic Theory, 2004
It has been shown that under perfect competition and constant returns-to-scale, a onesector real business cycle model may exhibit indeterminacy and sunspots when income tax rates are determined by a balanced-budget rule with a pre-set level of government expenditures. This paper shows that indeterminacy disappears if the government finances endogenous public spending and transfers with fixed income tax rates. Under this type of balanced-budget formulation, the economy exhibits saddle-path stability and equilibrium uniqueness, regardless of the source of government revenue and/or the existence of lumpsum transfers.
19-00007 Capital Income Taxation and Aggregate Instability
2019
This paper overturns the conventional wisdom that reliance on capital tax rate adjustment to ensure fiscal sustainability is immune to extrinsic uncertainty. The interaction of capital taxation and endogenous capital utilization generates fiscal increasing returns and factor share redistribution to induce sunspots expectations. Capital depreciation allowance debilitates this mechanism to preempt policy induced instability while achieving budget objective. Self-fulfilling fluctuations can occur in real-world economies, unless their depreciation allowances are sufficiently higher or income tax rates lower than the current levels. This adds a short-run motivation to the long-run approach to capital taxation and the supply-side view of fiscal policy reforms. We are grateful to Jess Benhabib, Bill Dupor, Albert Marcet, Martin Uribe, and audiences at various conferences and institutions for very insightful comments and suggestions. Citation: Kevin x.d. Huang and Qinglai Meng and Jianpo Xu...
Does Nonlinear Taxation Stabilize Small Open Economies
2018
This paper examines the stabilization effect of income taxation rules in small open economies. We show that if endogenous growth is not allowed, belief-driven fl?uctuation will not emerge, but the economy displays total instability under certain conditions and nonlinear income tax may recover saddle point stability. If endogenous growth is possible and if the taxation rule specifi?es the rate of income tax held in the balanced growth equi- librium, then equilibrium indeterminacy will not arise either. However, if the long run tax rate is not predetermined, then, equilibrium path of the economy may be indeterminate, and an appropriate taxation rule can establish determinacy.
Aggregate instability under balanced-budget consumption taxes: A re-examination
Journal of Economic Theory, 2013
We re-examine the destabilizing role of balanced-budget fiscal policy rules based on consumption taxation. Using a one-sector model with infinitely-lived households, and assuming that preferences are of the Greenwood-Hercovitz-Huffman [8] (GHH) type, we show that non-linear consumption taxation may destabilize the economy, promoting expectation-driven fluctuations, if the tax rate is countercyclical. We also exhibit a Laffer curve, which explains the multiplicity of steady states when the tax rate is counter-cyclical. All these results are mainly driven by the absence of income effect. Finally, a numerical illustration shows that consumption taxation may be a source of instability for most OECD countries.
Tax Policy and Stability in a Model with Sector-Specific Externalities
Review of Economic Dynamics, 2001
We show that in a two-sector real business cycle model with su¢ciently strong investment externalities, a regressive tax policy can stabilize the economy against ‡uctuations driven by agents' animal spirits. By contrast, this economy with a ‡at or progressive tax scheme (such as that in the U.S.) is more susceptible to indeterminacy and sunspot ‡uctuations. In the model with an aggregate constant returns-to-scale technology or a low investment externality, we show that a regressive tax policy can destabilize the economy by causing belief-driven ‡uctuations. Moreover, depending on the size of investment externalities and the slope parameter of the tax schedule, the economy exhibits various types of endogenous ‡uctuations, including Hopf or saddle-node bifurcations and stochastic sunspot equilibria.
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This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots only if the equilibrium wage-hours locus is positively sloped and steeper than the household's labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical ‡uctuations. Our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in U.S. output volatility after the Tax Reform Act of 1986 was implemented.
Progressive taxation and macroeconomic (In) stability with productive government spending
Journal of Economic Dynamics and Control, 2013
This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots only if the equilibrium wage-hours locus is positively sloped and steeper than the household's labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical ‡uctuations. Our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in U.S. output volatility after the Tax Reform Act of 1986 was implemented.