AGGREGATE AND DISTRIBUTIONAL EFFECTS OF TAX POLICY WITH INTERDEPENDENT PREFERENCES: THE ROLE OF “CATCHING UP WITH THE JONESES”

Murat Koyuncu and Stephen J Turnovsky

Macroeconomic Dynamics, 2010, vol. 14, issue S2, 200-223

Abstract: This paper analyzes the aggregate growth and distributional effects of tax policy using an endogenous growth model with heterogeneous agents having “catching up with the Joneses” (CUJ) types of preferences. We characterize the aggregate equilibrium of this economy, as well as its distributional properties, and show that the consumption externality present with CUJ preferences produces greater income inequality than is obtained with conventional time-separable preferences. The consumption externality substantially alters the effects of tax policy, mostly quantitatively, but in some cases qualitatively as well. Extensive numerical simulations are conducted and used to compare the consequences of different modes of taxation, highlighting the tradeoffs involved.

Date: 2010
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