Tax Policy and Stability in a Model with Sector-Specific Externalities

Jang-Ting Guo and Sharon Harrison

Review of Economic Dynamics, 2001, vol. 4, issue 1, 75-89

Abstract: We show that in a two-sector real business cycle model wtih sufficiently strong investment externalities, a regressive tax policy can stabilize the economy against fluctuations driven by agents' animal spirits. By contrast, this economy with a flat or progressive tax scheme (such as that in the U.S.) is more susceptible to indeterminacy and sunspot fluctuations. In the model with an aggregate constant returns-to-scale technology or a low investment externality, we show that a regressive tax policy can destablize the economy by causing belief-driven flucutations. Moreover, depending on the size of investment externalities and the slope parameter of the tax schedule, the economy exhibits various types of endogenous fluctuations, including Hopf or saddle-node bifurcations and stochastic sunspot equilibria. (Copyright: Elsevier)

Keywords: tax policy; stability; sector-specific externalities; indeterminacy (search for similar items in EconPapers)
JEL-codes: E32 E62 O41 (search for similar items in EconPapers)
Date: 2001
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Citations: View citations in EconPapers (33)

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DOI: 10.1006/redy.2000.0105

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