Tax Policy Under Keeping Up with the Joneses and Imperfect Competition
This paper examines the optimal (first-best) fiscal policy in a stochastic, infinite-horizon representative agent model that exhibits a ¡°keeping up with the Joneses¡± utility function and imperfectly competitive product markets. We find that the optimal labor tax is a constant, whose sign is determined by the relative strength of consumption externality and monopoly power. Moreover, the optimal capital tax is unambiguously negative and affects the economy countercyclically. Our analysis shows that models with capital accumulation, imperfect competition, and ¡°keeping up with the Joneses¡± preferences call for traditional Keynesian demand-management policies that are designed to mitigate business cycle fluctuations.
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