Aggregate Instability under Labor Income Taxation and Balanced-Budget Rules: Preferences Matter

Nicolas Abad, Thomas Seegmuller and Alain Venditti

No 1217, AMSE Working Papers from Aix-Marseille School of Economics, France

Abstract: We investigate the role of preferences in the existence of expectation-driven instability under a balanced budget rule where government spendings are financed by a tax on labor income. Considering a one-sector neoclassical growth model with a large class of preferences, we find that expectation-driven fluctuations are more likely when consumption and labor are Edgeworth substitutes. Under this property, an intermediate range of tax rates and a sufficiently low elasticity of intertemporal substitution in consumption lead to instability. Numerical simulations of the model support the conclusion that labor income taxation is a plausible source of instability in most OECD countries.

Keywords: Indeterminacy; expectation-driven business cycles; labor income taxes; balance-budget rule; infinite-horizon model. (search for similar items in EconPapers)
JEL-codes: C62 E32 E62 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2012-04, Revised 2012-04
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Working Paper: Aggregate Instability under Labor Income Taxation and Balanced-Budget Rules: Preferences Matter (2013)
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Persistent link: https://EconPapers.repec.org/RePEc:aim:wpaimx:1217

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