The Fiscal Theory of the Price Level When All Income is Taxed

Pedro Gomis-Porqueras, Solmaz Moslehi () and Vivianne Vilar

No 09-13, Monash Economics Working Papers from Monash University, Department of Economics

Abstract: In this paper we explore how the nature of the equilibria changes when the interest income from nominal bond holdings is also taxed in an fully flexible endowment economy. We find that the stability properties of this economy depend on the slope and the intercept of both monetary and fiscal policy rules. Thus, the parameter space consistent with locally determinate equilibria is much larger compared to that of Leeper (1991). For instance, deviations from the Taylor principle can still yield determinate equilibria even when fiscal policy does not aggressively respond to rises in debt levels. In addition, we show that if the government taxes all sources of income and the fiscal authority sets taxes taking into account the level of debt, then the economy exhibits a Laffer curve yielding multiple steady states. As we can see, ignoring the tax treatment of interest income generated by bond holdings is not as innocuous as it may seem.

Keywords: Taxes; Bond Income; Laffer Curve; Monetary and Fiscal Policy Interactions. (search for similar items in EconPapers)
JEL-codes: C11 E32 E62 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2013-05
New Economics Papers: this item is included in nep-mac, nep-pbe and nep-pub
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