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Fiscal Policy, Maintenance Allowances and Expectation-Driven Business Cycles

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Abstract

Firms devote significant resources to maintain and repair thei existing capital. Within a real business cycle model featuring arguably small aggregate increasing returns, this paper assesses the stabilizing effects of fiscal policies with a maintenance expenditure allowance. In this setup, firms are authorized to deduct their maintenance expenditures from revenues in calculating pre-tax profits, as in many prevailing tax codes. While flat-rate taxation does not prove useful to insulate the economy from self-fulfilling beliefs, a progressive tax can render the equilibrium unique. However, we show that the required progressivity to protect the economy against sunspot-driven fluctuations is increasing in the maintenance-to-GDP ratio. Taking into account the maintenance and repair activity of firms, and the tax deductibility of the related expenditures, would then weaken the expected stabilizing properties of progressive fiscal schedules.

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File URL: ftp://mse.univ-paris1.fr/pub/mse/CES2009/09031.pdf
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Paper provided by Université Panthéon-Sorbonne (Paris 1), Centre d'Economie de la Sorbonne in its series Documents de travail du Centre d'Economie de la Sorbonne with number 09031.

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Length: 23 pages
Date of creation: May 2009
Date of revision:
Handle: RePEc:mse:cesdoc:09031

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Keywords: Business cycles; maintenance and repair allowances; capital utilization; progressive income taxes; local indeterminacy and sunspots.;

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