Factor substitution and taxation in a finance constrained economy

Jianpo Xue and Chong Yip

Journal of Mathematical Economics, 2014, vol. 55, issue C, 101-112

Abstract: In this paper, we examine the effects of constant-rate factor taxation on macroeconomic stability in the Woodford (1986) model. Our focus is on how the degree of factor substitution, as measured by the elasticity of factor substitution (EOS) in production, affects different balanced-budget tax rules. Analytically, we show that indeterminacy can occur under capital income taxation only when the EOS is very low, whereas indeterminacy under labor income taxation is not subject to the EOS restriction. This finding is robust when we tax all of the factor incomes with equal rates. Thus, in terms of macroeconomic stability, taxing capital income is preferred to taxing labor income.

Keywords: Balanced-budget rules; Factor taxation; Elasticity of substitution; Indeterminacy (search for similar items in EconPapers)
Date: 2014
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Persistent link: https://EconPapers.repec.org/RePEc:eee:mateco:v:55:y:2014:i:c:p:101-112

DOI: 10.1016/j.jmateco.2014.10.004

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