Progressive Taxation and Monetary Policy in a Currency Union

Wolfgang Strehl and Philipp Engler

VfS Annual Conference 2015 (Muenster): Economic Development - Theory and Policy from Verein für Socialpolitik / German Economic Association

Abstract: We analyse the welfare properties of progressive income taxes in a stylized DSGE model of a currency union calibrated to the Eurozone. When the central bank follows a standard Taylor rule and volatility originates solely in productivity shocks, we find that considerable welfare gains can be achieved by introducing a progressive income tax schedule. The reason is that the slightly lower average levels of consumption and greater volatility of hours are more than offset in their effects on welfare by a significant reduction in consumption volatility. However, at the aggregate level this result is not robust to the introduction of rule-of-thumb households, but we find a positive welfare effect for the latter type of households while intertemporally optimizing households lose. Furthermore, under an optimal monetary policy, welfare falls even in the absence of rule-of-thumb households. When demand shocks are considered, progressive taxes cannot improve welfare. Increasing tax progression above the Eurozone average is a "beggar-thyself" policy for all specifications.

JEL-codes: E52 E62 F45 (search for similar items in EconPapers)
Date: 2015
New Economics Papers: this item is included in nep-cba, nep-dge, nep-mac, nep-mon and nep-pbe
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Persistent link: https://EconPapers.repec.org/RePEc:zbw:vfsc15:112823

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