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Optimal Fiscal Policy in a Business Cycle Model

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  • V. V. Chari
  • Lawrence J. Christiano
  • Patrick J. Kehoe

Abstract

This paper develops the quantitative implications of optimal fiscal policy in a business cycle model. In a stationary equilibrium the ex ante tax rate on capital income is approximately zero. There is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation. Within this class the optimal ex post capital tax rates can range from being close to i.i.d. to being close to a random walk. The tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks and thus there is no presumption that optimal labor tax rates follow a random walk. The welfare gains from smoothing labor tax rates and making ex ante capital income tax rates zero are small and most of the welfare gains come from an initial period of high taxation on capital income.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4490.

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Date of creation: Oct 1993
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Publication status: published as Journal of Political Economy, vol. 102, no. 3, August 1994
Handle: RePEc:nbr:nberwo:4490

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  1. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Atkinson, A. B. & Stiglitz, J. E., 1972. "The structure of indirect taxation and economic efficiency," Journal of Public Economics, Elsevier, Elsevier, vol. 1(1), pages 97-119, April.
  3. Pestieau, P. M., 1974. "Optimal taxation and discount rate for public investment in a growth setting," Journal of Public Economics, Elsevier, Elsevier, vol. 3(3), pages 217-235, August.
  4. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis, issue Fall, pages 9-22.
  5. Cooley, T.F. & Hansen, G.D., 1991. "The Distortions in a Neoclassical Monetary Economy," Papers, Rochester, Business - General 91-01, Rochester, Business - General.
  6. Chari, V V & Christiano, Lawrence J & Kehoe, Patrick J, 1994. "Optimal Fiscal Policy in a Business Cycle Model," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 102(4), pages 617-52, August.
  7. Robert J. Barro & Chaipat Sahasakul, 1983. "Measuring the Average Marginal Tax Rate from the Individual Income Tax," University of Chicago - George G. Stigler Center for Study of Economy and State, Chicago - Center for Study of Economy and State 26, Chicago - Center for Study of Economy and State.
  8. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations," American Economic Review, American Economic Association, American Economic Association, vol. 82(3), pages 430-50, June.
  9. Martin L. Weitzman, 1973. "Duality Theory for Infinite Horizon Convex Models," Management Science, INFORMS, INFORMS, vol. 19(7), pages 783-789, March.
  10. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, Econometric Society, vol. 50(6), pages 1345-70, November.
  11. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(2), pages 410-452, December.
  12. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers, Northwestern University, Center for Mathematical Studies in Economics and Management Science 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  13. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, Econometric Society, vol. 54(3), pages 607-22, May.
  14. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 101(3), pages 485-517, June.
  15. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 87(5), pages 940-71, October.
  16. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, Elsevier, vol. 21(2-3), pages 247-280.
  17. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 90(359), pages 529-49, September.
  18. Atkinson, A B, 1971. "Capital Taxes, the Redistribution of Wealth and Individual Savings," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 38(114), pages 209-227, April.
  19. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, Elsevier, vol. 58(2), pages 250-289, December.
  20. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
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  1. > Macroeconomics > Economic Fluctuations > Real Business Cycle Theory
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  1. Quantitative Macroeconomics and Real Business Cycles (QM&RBC)

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