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A Note on Balanced-Budget Income Taxes and Aggregate (In)Stability in Multi-Sector Economies

Nicolas Abad and Alain Venditti ()

No 1828, AMSE Working Papers from Aix-Marseille School of Economics, France

Abstract: We examine the impact of balanced-budget labor income taxes on the existence of expectation- driven business cycles in a two-sector version of the Schmitt-Grohé and Uribe (SGU) [18] model with constant government expenditures and counter-cyclical taxes. Our results show that the destabilizing impact of labor income taxes strongly depends on the capital intensity difference across sectors. Local indeterminacy is indeed more likely when the consumption good sector is capital intensive, as the minimal tax rate decreases, and less likely when the investment good sector is capital intensive, as the minimal tax rate increases. The implication of this result can be quantitatively significant. Indeed, when compared to SGU, local indeterminacy can be either completely ruled out for all OECD countries when the investment good is sufficiently capital intensive, or drastically improved, delivering indeterminacy for a larger set of OECD countries, if the consumption good is sufficiently capital intensive. Focusing however on recent estimates of the sectoral capital shares corresponding to the empirically plausible case of a capital intensive consumption good, we find that there is a significant increase of the range of economically relevant labor tax rates (from a minimum tax rate of 30% to 24.7%) for which local indeterminacy arises with respect to the aggregate formulation of SGU.

Keywords: aggregate (in)stability; local indeterminacy; expectations-driven fluctuations; labor income taxes; balanced-budget rule; infinite-horizon two-sector model; capital intensity difference (search for similar items in EconPapers)
JEL-codes: C62 E32 O41 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-mac
Date: 2018-06
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