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Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes

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  • Chryssi Giannitsarou

Abstract

It is known that, in the context of a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise as a result of endogenously determined labor income tax rates. This happens for a range of empirically plausible tax rates and this range is amplified if government expenditures are financed by a combination of capital and labor income taxes. This paper revisits the issue of indeterminacy and aggregate instability when government expenditures may be financed by consumption taxes as well. It is shown that by introducing consumption taxes, the ranges of indeterminacies shrink, thus reducing the possibility of aggregate instability. The results also provide an additional argument in favor of (the less distortionary) consumption taxes in place of capital taxes.

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Bibliographic Info

Paper provided by Econometric Society in its series Econometric Society 2004 North American Winter Meetings with number 498.

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Date of creation: 11 Aug 2004
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Handle: RePEc:ecm:nawm04:498

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Keywords: Fiscal policy; consumption tax; balanced budget rules; indeterminacy;

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  1. Schmitt-Grohe, Stephanie & Uribe, Martin, 1997. "Balanced-Budget Rules, Distortionary Taxes, and Aggregate Instability," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 976-1000, October.
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  3. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  4. Guo, Jang-Ting & Harrison, Sharon G., 2004. "Balanced-budget rules and macroeconomic (in)stability," Journal of Economic Theory, Elsevier, vol. 119(2), pages 357-363, December.
  5. Evans George W & McGough Bruce, 2005. "Indeterminacy and the Stability Puzzle in Non-Convex Economies," The B.E. Journal of Macroeconomics, De Gruyter, vol. 5(1), pages 1-46, September.
  6. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  7. King, Robert G. & Plosser, Charles I. & Rebelo, Sergio T., 1988. "Production, growth and business cycles : I. The basic neoclassical model," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 195-232.
  8. Asea, Patrick & Mendoza, Enrique G & Milesi-Ferretti, Gian Maria, 1996. "On the Ineffectiveness of Tax Policy in Altering Long- Run Growth: Harberger's Superneutrality Conjecture," CEPR Discussion Papers 1378, C.E.P.R. Discussion Papers.
  9. Mendoza, Enrique G. & Razin, Assaf & Tesar, Linda L., 1994. "Effective tax rates in macroeconomics: Cross-country estimates of tax rates on factor incomes and consumption," Journal of Monetary Economics, Elsevier, vol. 34(3), pages 297-323, December.
  10. Alesina, Alberto & Perotti, Roberto, 1996. "Fiscal Discipline and the Budget Process," American Economic Review, American Economic Association, vol. 86(2), pages 401-07, May.
  11. Hansen, Gary D., 1985. "Indivisible labor and the business cycle," Journal of Monetary Economics, Elsevier, vol. 16(3), pages 309-327, November.
  12. Duffy, John & Xiao, Wei, 2007. "Instability of sunspot equilibria in real business cycle models under adaptive learning," Journal of Monetary Economics, Elsevier, vol. 54(3), pages 879-903, April.
  13. Uhlig, H., 1995. "A toolkit for analyzing nonlinear dynamic stochastic models easily," Discussion Paper 1995-97, Tilburg University, Center for Economic Research.
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