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

Nicolas Abad, Thomas Seegmuller and Alain Venditti

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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; infinite-horizon model; labor income taxes; balanced-budget rule (search for similar items in EconPapers)
Date: 2013-11
Note: View the original document on HAL open archive server: https://shs.hal.science/halshs-00793213v2
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Working Paper: Aggregate Instability under Labor Income Taxation and Balanced-Budget Rules: Preferences Matter (2012)
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