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The Laffer Curve in an Incomplete-Market Economy

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  • Fève, Patrick
  • Matheron, Julien
  • Sahuc, Jean-Guillaume

Abstract

This paper is a quantitative investigation into the characteristics of the Laffer curve in a neoclassical growth model with incomplete markets and heterogeneous, liquidity-constrained agents. We show that the shape of the Laffer curves related to taxes on labor, capital and consumption dramatically changes depending on which of transfers or government debt are adjusted to make the government budget constraint hold. When transfers are adjusted, the Laffer curve has the traditional shape. However, when debt is adjusted, the Laffer curve looks like a horizontal S, in which case fiscal revenues can be associated with up to three diferent levels of taxation. This finding occurs because the tax rates change non monotonically with public debt when markets are incomplete.

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Bibliographic Info

Paper provided by Toulouse School of Economics (TSE) in its series TSE Working Papers with number 12-288.

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Date of creation: Apr 2012
Date of revision: Jul 2013
Handle: RePEc:tse:wpaper:25754

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  1. Mathias Trabandt & Harald Uhlig, 2006. "How Far Are We From The Slippery Slope? The Laffer Curve Revisited," SFB 649 Discussion Papers SFB649DP2006-023, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
  2. Javier Díaz-Giménez & Andrew Glover & José-Víctor Ríos-Rull, 2011. "Facts on the distributions of earnings, income, and wealth in the United States: 2007 update," Quarterly Review, Federal Reserve Bank of Minneapolis, Federal Reserve Bank of Minneapolis.
  3. Jorge Alonso-Ortiz & Richard Rogerson, 2010. "Taxes, transfers, and employment in an incomplete markets model," CQER Working Paper 2010-07, Federal Reserve Bank of Atlanta.
  4. Sigrid Röhrs & Christoph Winter, 2011. "Wealth inequality and the optimal level of government debt," ECON - Working Papers, Department of Economics - University of Zurich 051, Department of Economics - University of Zurich.
  5. Heathcote, Jonathan, 2001. "Fiscal Policy with Heterogeneous Agents and Incomplete Markets," Working Papers, Duke University, Department of Economics 01-03, Duke University, Department of Economics.
  6. David Domeij & Jonathan Heathcote, 2004. "On The Distributional Effects Of Reducing Capital Taxes," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 45(2), pages 523-554, 05.
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Cited by:
  1. Hans A. Holter & Dirk Krueger & Serhiy Stepanchuk, 2014. "How Does Tax Progressivity and Household Heterogeneity Affect Laffer Curves?," PIER Working Paper Archive 14-015, Penn Institute for Economic Research, Department of Economics, University of Pennsylvania.

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