Progressive taxation and macroeconomic (In) stability with productive government spending

Shu-Hua Chen and Jang-Ting Guo

Journal of Economic Dynamics and Control, 2013, vol. 37, issue 5, 951-963

Abstract: This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots if and only if the equilibrium after-tax wage-hours locus is positively sloped and steeper than the household's labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical fluctuations. Moreover, our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in US output volatility after the Tax Reform Act of 1986 was implemented.

Keywords: Progressive income taxation; Equilibrium (in)determinacy; Productive government spending; Business cycles (search for similar items in EconPapers)
JEL-codes: E32 E62 (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (28)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:dyncon:v:37:y:2013:i:5:p:951-963

DOI: 10.1016/j.jedc.2013.01.004

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