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The Real Cost Channel and Optimal Labor Taxation at the Zero Lower Bound

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  • Haoan Wang
  • Haochun Ma
  • He Nie

Abstract

We study optimal labor income taxation at the zero lower bound in a New Keynesian model with a real cost channel (RCC). With costless state‐contingent taxation, optimal inflation and output are invariant to the RCC. A unified wedge identity determines the tax correction that offsets the RCC, increasing the crisis tax hike and attenuating the recovery tax cut under fiscal forward guidance. We then introduce the cost of state‐contingent tax revisions, under which the RCC can affect the optimal allocation by altering implementation costs. The difference between optimal taxes contains both the RCC correction and an allocation‐adjustment term, with the latter vanishing in the costless benchmark.

Suggested Citation

  • Haoan Wang & Haochun Ma & He Nie, 2026. "The Real Cost Channel and Optimal Labor Taxation at the Zero Lower Bound," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 28(5), October.
    • Handle: RePEc:bla:jpbect:v:28:y:2026:i:5:n:e70145
    DOI: 10.1111/jpet.70145
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