Income Taxation Rules and Stability of a Small Open Economy

Been-Lon Chen, Yunfang Hu and Kazuo Mino

Journal of Macroeconomics, 2020, vol. 65, issue C

Abstract: This paper examines the stability of a small open economy under alternative income taxation rules. Using a one-sector real business cycle model with external increasing returns, we show that if the income tax schedule is linear, the small open economy will not generate equilibrium indeterminacy, but it exhibits a diverging behavior under certain conditions. In this case, an appropriate choice of nonlinear tax on the factor income may recover the saddle-point stability. We also reveal that if the taxation on the interest income on financial assets is regressive, then the small open economy may exhibit equilibrium indeterminacy. In this situation, a progressive tax rule on the interest income can contribute to eliminating sunspot-driven fluctuations.

Keywords: Income taxation rule; Equilibrium indeterminacy; Built-in stabilizer; Small open economy (search for similar items in EconPapers)
JEL-codes: E62 O41 (search for similar items in EconPapers)
Date: 2020
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Working Paper: Income Taxation Rules and Stability of a Small Open Economy (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jmacro:v:65:y:2020:i:c:s0164070420301622

DOI: 10.1016/j.jmacro.2020.103236

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