Fiscal Uncertainty in Habit-Forming and Lumpy Economies

Matteo Ghilardi and Roy Zilberman

No 431361324, Working Papers from Lancaster University Management School, Economics Department

Abstract: We study dividend-tax-induced fiscal uncertainty tied to deficit-financing concerns in a production-based general equilibrium model with habit-forming consumption and partially irreversible investment. Habits generate countercyclical investment and asset price dynamics following tax adjustments. Irreversibility and tax risk, in turn, bring asset price volatility closer to the data, trigger lumpy investment behavior, and raise medium-run fiscal spending multipliers. Tax-smoothing and irreversibility significantly enhance welfare despite increased valuation risk, while also revealing a trade-off between debt stabilization and stock price volatility. The irreversibility-habit-augmented model reconciles the limited decline and rapid recovery (i.e., lumpiness) in nonfinancial corporate investment following the 2012 American Taxpayer Relief Act.

Keywords: partial irreversibility; habit formation; asset prices; deficit-financing dividend taxes; public debt (search for similar items in EconPapers)
Date: 2025
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