Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes
It is known that in a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise due to endogenous labour income tax rates. This article shows that when the government finances its expenditures via an endogenous consumption tax instead, a steady state is always saddle-path stable. Consequently, combining income taxes with consumption taxes makes the ranges of indeterminacy shrink, thus reducing the possibility of aggregate instability. From a policy perspective, the results provide an additional argument in favour of consumption taxes in place of capital taxes. Copyright 2007 The Author(s). Journal compilation Royal Economic Society 2007.
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Volume (Year): 117 (2007)
Issue (Month): 523 (October)
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