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Are Consumption Taxes Preferable To Income Taxes For Preventing Macroeconomic Instability?

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  • McKnight, Stephen

Abstract

This paper examines the local determinacy implications of using consumption taxes and income taxes to finance a balanced budget fiscal policy for a variety of popular monetary policy rules. It is shown using a New Keynesian framework that the severity of the indeterminacy problem that arises under each tax system depends not only on the specification of the interest-rate feedback rule, but also on the magnitude of the steady state tax rate, the steady state government debt–output ratio, and the degree of price stickiness. Significant differences in the determinacy criteria across the two tax systems are found to exist. The robustness of the results is assessed by extending the baseline model to include capital accumulation and the taxation of bond interest income. From a policy perspective, our results suggest that future shifts toward indirect taxation could have nontrivial implications for the setting of monetary policy under balanced budget rules, in particular the ability of the Taylor principle to achieve determinacy.

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  • McKnight, Stephen, 2017. "Are Consumption Taxes Preferable To Income Taxes For Preventing Macroeconomic Instability?," Macroeconomic Dynamics, Cambridge University Press, vol. 21(4), pages 1023-1058, June.
  • Handle: RePEc:cup:macdyn:v:21:y:2017:i:04:p:1023-1058_00
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    Cited by:

    1. Fujisaki, Seiya, 2017. "Equilibrium Determinacy in a Two-Tax System with Utility from Government Expenditure," MPRA Paper 81214, University Library of Munich, Germany.
    2. Fujisaki, Seiya, 2016. "Macroeconomic Effect of Consumption Tax on ”Dynamic” and ”Myopic” Agents," MPRA Paper 73500, University Library of Munich, Germany.

    More about this item

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy

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