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Fiscal Policy with Heterogeneous Agents and Incomplete Markets

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  • Heathcote, Jonathan

Abstract

I undertake a quantitative investigation into the short run effects of changes in the timing of taxes for model economies in which heterogeneous households face a borrowing constraint. A combination of the distortionary effects of non-lump-sum taxation and the liquidity effects arising from the asset market structure are found to imply large real effects from tax changes. For example, a temporary proportional income tax increase in the benchmark model economy reduces aggregate consumption by around 29 cents for every additional dollar of tax revenue raised. The consumption of low wealth households who are close to the borrowing constraint is most sensitive to the current tax rate. While there are many such households, richer households account for a disproportionately large fraction of aggregate income and consumption. Thus the distortionary effects of proportional taxation are quantitatively more important at the aggregate level than the effects associated with incompleteness of asset markets.

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  • Heathcote, Jonathan, 2001. "Fiscal Policy with Heterogeneous Agents and Incomplete Markets," Working Papers 01-03, Duke University, Department of Economics.
  • Handle: RePEc:duk:dukeec:01-03
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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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