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Optimal Fiscal Policy In A Business Cycle Model: Alternative Identifications Of The Optimal Expost Capital Income Tax Rates

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  • Baltasar Manzano

    (Universidad de Vigo)

  • Jess Ruz

    (Universitat Autnoma de Barcelona)

Abstract

This paper deals with the indeterminacy of optimal fiscal policy treated by Zhu (1992) and Chari, Christiano and Kehoe (1994). These authors identify the optimal fiscal policy restricting the debt return to be uncontingent to the state of nature. In this paper we use other kind of restrictions in order to identify the optimal fiscal policy. Using the solution method proposed by Sims (1998), we can select an equilibrium by enforcing a stable path for the bonds allocation, to identify all the fiscal policy variables contingent to the state of nature. We also use a decomposition of the expectational terms that allow us to obtain the ex-ante capital income tax rate in order to be compared with the ex-post (contingent) tax rate. We can demonstrate that the risk aversion changes the relationship between the expectational errors of the private agents and the sources of fluctuations. The numerical simulation provides some different results: the optimal tax rate on capital incom e is constant, instead of the very volatile tax rate obtained by Chari, Christiano and Kehoe (1994). This property remains unaltered when we use alternative restrictions (exogenous debt path and exogenous expectational errors) to identify the contingent optimal fiscal policy.

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Bibliographic Info

Paper provided by Society for Computational Economics in its series Computing in Economics and Finance 2000 with number 351.

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Date of creation: 05 Jul 2000
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Handle: RePEc:sce:scecf0:351

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Postal: CEF 2000, Departament d'Economia i Empresa, Universitat Pompeu Fabra, Ramon Trias Fargas, 25,27, 08005, Barcelona, Spain
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  1. 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, vol. 101(3), pages 485-517, June.
  2. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  3. Larry E. Jones & Rodolfo E. Manuelli & Peter E. Rossi, 1993. "On the Optimal Taxation of Capital Income," NBER Working Papers 4525, National Bureau of Economic Research, Inc.
  4. Bohn, Henning, 1994. "Optimal state-contingent capital taxation: when is there an indeterminacy?," Journal of Monetary Economics, Elsevier, vol. 34(1), pages 125-137, August.
  5. V. V. Chari & Patrick J. Kehoe & Ellen R. McGrattan, 1996. "Sticky Price Models of the Business Cycle: Can the Contract Multiplier Solve the Persistence Problem?," NBER Working Papers 5809, National Bureau of Economic Research, Inc.
  6. Roger E. A. Farmer, 1997. "Money in a real business cycle model," Proceedings, Federal Reserve Bank of Cleveland, issue Nov, pages 568-623.
  7. Benhabib, J. & Farmer, R.E.A, 1991. "Indeterminacy and Increasing Returns," Papers 165, Cambridge - Risk, Information & Quantity Signals.
  8. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1991. "Optimal fiscal policy in a stochastic growth model (technical appendix)," Working Papers 473, Federal Reserve Bank of Minneapolis.
  9. V.V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report 160, Federal Reserve Bank of Minneapolis.
  10. Azariadis, Costas, 1981. "Self-fulfilling prophecies," Journal of Economic Theory, Elsevier, vol. 25(3), pages 380-396, December.
  11. 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.
  12. Kevin J. Lansing, 1998. "Optimal Fiscal Policy in a Business Cycle Model with Public Capital," Canadian Journal of Economics, Canadian Economics Association, vol. 31(2), pages 337-364, May.
  13. Scott, Andrew, 1999. "Does Tax Smoothing Imply Smooth Taxes?," CEPR Discussion Papers 2172, C.E.P.R. Discussion Papers.
  14. Roger E. A. Farmer, 1999. "Macroeconomics of Self-fulfilling Prophecies, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 0262062038, December.
  15. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
  16. Alfonso Novales & Emilio Dominguez & Javier J. Perez & Jesus Ruiz, 1998. "Solving Non-linear Rational Expectations Models By Eigenvalue-Eigenvector Decompositions," QM&RBC Codes 124, Quantitative Macroeconomics & Real Business Cycles.
  17. Roger E.A. Farmer, 1994. "Indeterminacy and Sector-Specific Externalities," UCLA Economics Working Papers 722, UCLA Department of Economics.
  18. 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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