Optimal Fiscal Policy in a Model of Firm Entry and Financial Frictions

Dudley Cooke (d.cooke@exeter.ac.uk) and Tatiana Damjanovic (tatiana.damjanovic@durham.ac.uk)
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Dudley Cooke: University of Exeter

No 2016_02, CEMAP Working Papers from Durham University Business School

Abstract: This paper develops a general equilibrium model of firm entry and financial frictions. Movements in the volatility of firm-level shocks and aggregate productivity generate procyclical entry and a countercyclical firm default rate. We derive analytical results for optimal fiscal policy and show that the government faces two trade-offs. The first arises from a profit destruction and a consumer surplus effect when firm entry is endogenous. The second arises because financial frictions reduce firm entry and default is costly. We also study the optimal mix of taxes on labor-income and firm profits in a quantitative version of the model. We find that a countercyclical labor-income tax is always part of the optimal fiscal policy, whereas the cyclicality of the profit tax is sensitive to the source of aggregate fluctuations.

Keywords: Firm Entry; Financial Frictions; Optimal Fiscal Policy (search for similar items in EconPapers)
JEL-codes: E31 E52 F41 (search for similar items in EconPapers)
Date: 2016-06
New Economics Papers: this item is included in nep-dge, nep-mac and nep-sog
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