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Progressive taxation and macroeconomic (In) stability with productive government spending

  • Chen, Shu-Hua
  • Guo, Jang-Ting

This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots if and only if the equilibrium after-tax wage-hours locus is positively sloped and steeper than the household's labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical fluctuations. Moreover, our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in US output volatility after the Tax Reform Act of 1986 was implemented.

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Article provided by Elsevier in its journal Journal of Economic Dynamics and Control.

Volume (Year): 37 (2013)
Issue (Month): 5 ()
Pages: 951-963

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Handle: RePEc:eee:dyncon:v:37:y:2013:i:5:p:951-963
Contact details of provider: Web page: http://www.elsevier.com/locate/jedc

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