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Tax Policy and Stability in a Model with Sector-Specific Externalities

Author

Listed:
  • Jang-Ting Guo

    (University of California, Riverside)

  • Sharon G. Harrison

    (Barnard College, Columbia University)

Abstract

We show that in a two-sector real business cycle model wtih sufficiently strong investment externalities, a regressive tax policy can stabilize the economy against fluctuations driven by agents' animal spirits. By contrast, this economy with a flat or progressive tax scheme (such as that in the U.S.) is more susceptible to indeterminacy and sunspot fluctuations. In the model with an aggregate constant returns-to-scale technology or a low investment externality, we show that a regressive tax policy can destablize the economy by causing belief-driven flucutations. Moreover, depending on the size of investment externalities and the slope parameter of the tax schedule, the economy exhibits various types of endogenous fluctuations, including Hopf or saddle-node bifurcations and stochastic sunspot equilibria. (Copyright: Elsevier)

Suggested Citation

  • Jang-Ting Guo & Sharon G. Harrison, 2001. "Tax Policy and Stability in a Model with Sector-Specific Externalities," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(1), pages 75-89, January.
  • Handle: RePEc:red:issued:v:4:y:2001:i:1:p:75-89 DOI: 10.1006/redy.2000.0105
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Chen, Shu-Hua & Guo, Jang-Ting, 2013. "Progressive taxation and macroeconomic (In) stability with productive government spending," Journal of Economic Dynamics and Control, Elsevier, pages 951-963.
    2. Fujio Takata, 2017. "Two Steady States and Two Movement Patterns under the Balanced Budget Rule - An Economy with Divisible Labor," Discussion Papers 1702, Graduate School of Economics, Kobe University.
    3. Juin-Jen Chang & Jang-Ting Guo & Jhy-Yuan Shieh & Wei-Neng Wang, 2015. "Sectoral Composition Of Government Spending And Macroeconomic (In)Stability," Economic Inquiry, Western Economic Association International, vol. 53(1), pages 23-33, January.
    4. Fujio Takata, 2013. "Multiple Steady States under the Balanced Budget Rule- a Generalization," Discussion Papers 1310, Graduate School of Economics, Kobe University.
    5. Fujio Takata, 2015. "Two Movement Patterns under the Balanced Budget Rule |Further Results," Discussion Papers 1510, Graduate School of Economics, Kobe University.
    6. Sergey Slobodyan, 2004. "One Sector Models, Indeterminacy, and Productive Public Spending," Computing in Economics and Finance 2004 314, Society for Computational Economics.
    7. Jang-Ting Guo & Sharon G. Harrison, 2015. "Indeterminacy with Progressive Taxation and Sector-Specific Externalities," Pacific Economic Review, Wiley Blackwell, vol. 20(2), pages 268-281, May.
    8. Jang-Ting Guo & Juin-Jen Chang & Jhy-Yuan Shieh & Wei-Neng Wang, 2017. "Sectoral Composition of Government Spending, Distortionary Income Taxation, and Macroeconomic (In)stabilit," Working Papers 201702, University of California at Riverside, Department of Economics.
    9. Erkki Koskela & Mikko Puhakka, 2003. "Stabilizing Competitive Cycles with Distortionary Taxation," CESifo Working Paper Series 947, CESifo Group Munich.
    10. Kim, Jinill, 2005. "Does utility curvature matter for indeterminacy?," Journal of Economic Behavior & Organization, Elsevier, vol. 57(4), pages 421-429, August.
    11. Erkki Koskela & Mikko Puhakka, 2006. "Indeterminacy and Stabilization of Endogenous Cycles with Balanced-Budget Distortionary Taxation," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 62(2), pages 149-167, June.
    12. Sergey Slobodyan, 2004. "One Sector Models, Indeterminacy, and Productive Public Spending," Computing in Economics and Finance 2004 314, Society for Computational Economics.
    13. Patrick Pintus, 2004. "International Capital Mobility and Aggregate Volatility: the Case of Credit-Rationed Open Economies," Computing in Economics and Finance 2004 193, Society for Computational Economics.
    14. Chen, Shu-Hua & Guo, Jang-Ting, 2014. "Progressive taxation and macroeconomic (in)stability with utility-generating government spending," Journal of Macroeconomics, Elsevier, pages 174-183.
    15. Chen, Yan & Zhang, Yan, 2008. "Are Progressive Income Taxes Stabilizing? : A Reply," MPRA Paper 11460, University Library of Munich, Germany.
    16. Mauro Bambi & Aurélien Saïdi, 2008. "Increasing Returns to Scale and Welfare: Ranking the Multiple Deterministic Equilibria," CER-ETH Economics working paper series 08/99, CER-ETH - Center of Economic Research (CER-ETH) at ETH Zurich.
    17. Gokan, Yoichi, 2013. "Indeterminacy, labor and capital income taxes, and non-linear tax schedules," Journal of Macroeconomics, Elsevier, pages 138-149.
    18. Patrick A. Pintus, 2008. "Laffer traps and monetary policy," Review, Federal Reserve Bank of St. Louis, issue May, pages 165-174.
    19. Nicolas Dromel & Patrick-Antoine Pintus, 2006. "Are Progressive Fiscal Rules Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00410452, HAL.
    20. Chen, Shu-Hua & Guo, Jang-Ting, 2014. "Progressive taxation and macroeconomic (in)stability with utility-generating government spending," Journal of Macroeconomics, Elsevier, pages 174-183.

    More about this item

    Keywords

    tax policy; stability; sector-specific externalities; indeterminacy;

    JEL classification:

    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models

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