Endogenous income taxes and indeterminacy in dynamic models: When Diamond meets Ramsey again

Yan Zhang and Yan Chen

MPRA Paper from University Library of Munich, Germany

Abstract: This paper introduces fiscal increasing returns, through endogenous labor income tax rates as in Schmitt-Grohe and Uribe (1997), into the overlapping generations model with endogenous labor, consumption in both periods of life and homothetic preferences (e.g., Lloyd-Braga, Nourry and Venditti, 2007). We show that under numerical calibrations of the parameters, local indeterminacy can occur for distortionary tax rates that are empirically plausible for the U.S. economy, provided that the elasticity of capital-labor substitution and the wage elasticity of the labor supply are large enough, and the elasticity of intertemporal substitution in consumption is slightly greater than unity. These indeterminacy conditions are similar to those obtained within infinite horizon models and from this point of view, Diamond meets Ramsey again.

Keywords: Indeterminacy; Endogenous labor income tax rate. (search for similar items in EconPapers)
JEL-codes: C62 E32 (search for similar items in EconPapers)
Date: 2009-10-01
New Economics Papers: this item is included in nep-dge and nep-mac
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Citations: View citations in EconPapers (1)

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