Taxes and stabilization in contemporary macroeconomic models

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Taxes and stabilization in contemporary macroeconomic models

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Kenneth Kletzer ()

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Kenneth Kletzer

Abstract

The role of proportional and procyclic labor income taxes for automatic stabilization with stochastic productivity is analyzed in a contemporary macroeconomic model based on imperfect competition. The importance of short-run nominal wage rigidity for the effectiveness of progressive taxes on labor income for stabilizing output and raising household welfare is examined in a model that yields complete analytical solutions with stochastic output shocks. Increasing the procyclicity of labor income tax rates raises welfare with and without rigid nominal wages in the model economy. With fully flexible prices and wages, a positive covariance between the distortionary tax rate and productivity reduces the volatility of production and employment. This effect disappears under nominal wage rigidity, although progressive taxation can still raise welfare by reducing the distortion caused by a proportional labor tax. With rigid nominal wages and flexible consumer goods prices, payroll taxes levied at rates that rise with output can serve as automatic stabilizers. Copyright Springer Science + Business Media, LLC 2006

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Article provided by Springer in its journal International Tax and Public Finance.

Volume (Year): 13 (2006)
Issue (Month): 4 (August)
Pages: 351-371
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Handle: RePEc:kap:itaxpf:v:13:y:2006:i:4:p:351-371

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

Kenneth L. Judd, 2002. "Capital-Income Taxation with Imperfect Competition," American Economic Review, American Economic Association, vol. 92(2), pages 417-421, May. [Downloadable!]
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Other versions:
- Maurice Obstfeld & Kenneth Rogoff, 2000. "New Directions for Stochastic Open Economy Models," International Finance 0004002, EconWPA. [Downloadable!]
- Maurice Obstfeld & Kenneth Rogoff, 1999. "New Directions for Stochastic Open Economy Models," NBER Working Papers 7313, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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Other versions:
- Obstfeld, M., 1998. "Risk and Exchange Rate," Papers 193, Princeton, Woodrow Wilson School - Public and International Affairs.

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(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

Ioana Moldovan, 2007. "Countercyclical Taxes in a Monopolistically Competitive Environment," Working Papers 2007_42, Department of Economics, University of Glasgow. [Downloadable!]

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