Progressive taxation as an automatic stabilizer under nominal wage rigidity and preference shocks (original) (raw)

International Journal of Economic Theory

Abstract

Previous research has shown that in the context of a prototypical New Keynesian model, more progressive income taxation may lead to higher volatilities of hours worked and total output in response to a monetary disturbance. We analytically show that this business-cycle destabilization result is overturned within an otherwise identical macroeconomy subject to impulses to the household's utility formulation. Under a continuously or linearly progressive fiscal policy rule, an increase in the tax progressivity will always raise the degree of equilibrium nominal-wage rigidity, and thus serve as an automatic stabilizer that mitigates cyclical fluctuations driven by preference shocks. Our analysis illustrates that whether a more progressive tax schedule (de)stabilizes the business cycle depends crucially on the underlying driving source.

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