Progressive taxation as an automatic stabilizer under nominal wage rigidity and preference shocks

Miroslav Gabrovski and Jang-Ting Guo

International Journal of Economic Theory, 2022, vol. 18, issue 3, 232-246

Abstract: Previous research has shown that in the context of a prototypical New Keynesian model, more progressive income taxation may lead to higher volatility 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 with the symmetric‐equilibrium tax burden unchanged, an increase in the positive level of 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.

Date: 2022
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