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Progressive income taxes and macroeconomic instability

  • Mohanad Ismael


    (EPEE, University of Evry Val d'Essonne)

This paper aims to study the stability properties of a two-period over- lapping generations model (OLG) with a progressive labor-income taxa- tion rule. In this case, wage income tax rates are increasing with agent's income. Each representative agent lives two periods: youth and adult- hood. In the first period, agents choose labor supply and allocate their after-tax income between consumptions and savings (capital accumula- tions). In the second period, agents are retired and consume entirely their savings returns. It is shown that progressive labor-income taxation policy acts as a destabilizing factor in the sense that a higher progressivity makes the emergence of indeterminacy and endogenous fluctuations more likely. These fluctuations appear if the elasticity of capital-labor substi- tution is sufficiently low. Moreover, we show that saving rate widens the range of parameters giving rise to endogenous fluctuations. The analytical findings are completed by a numerical example.

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Paper provided by Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne in its series Documents de recherche with number 10-13.

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Length: 16 pages
Date of creation: 2010
Date of revision:
Handle: RePEc:eve:wpaper:10-13
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  1. Teresa Lloyd-Braga & Leonor Modesto & Thomas Seegmuller, 2008. "Tax Rate Variability and Public Spending as Sources of Indeterminacy," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(3), pages 399-421, 06.
  2. Cazzavillan, Guido & Lloyd-Braga, Teresa & Pintus, Patrick, 1996. "Multiple steady states and endogenous fluctuations with increasing returns to scale in production," CEPREMAP Working Papers (Couverture Orange) 9618, CEPREMAP.
  3. Dromel, Nicolas L. & Pintus, Patrick A., 2007. "Linearly progressive income taxes and stabilization," Research in Economics, Elsevier, vol. 61(1), pages 25-29, March.
  4. Chen, Yan & Zhang, Yan, 2009. "Endogenous income taxes in OLG economies: A clarification," MPRA Paper 16824, University Library of Munich, Germany.
  5. Nicolas Dromel & Patrick-Antoine Pintus, 2006. "Are Progressive Fiscal Rules Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00410452, HAL.
  6. Guo, Jang-Ting, 1999. "Multiple equilibria and progressive taxation of labor income," Economics Letters, Elsevier, vol. 65(1), pages 97-103, October.
  7. Jang-Ting Guo & Kevin J. Lansing, 1997. "Indeterminacy and stabilization policy," Working Paper 9708, Federal Reserve Bank of Cleveland.
  8. Nicolas Dromel & Patrick-Antoine Pintus, 2008. "Are Progressive Income Taxes Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00640857, HAL.
  9. Guido Cazzavillan & Patrick A. Pintus, 2004. "Robustness of Multiple Equilibria in OLG Economies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 7(2), pages 456-475, April.
  10. Sorger, Gerhard, 2002. "On the Long-Run Distribution of Capital in the Ramsey Model," Journal of Economic Theory, Elsevier, vol. 105(1), pages 226-243, July.
  11. Sharon Harrison & Jang-Ting Guo, 2006. "Useful Government Spending and Macroeconomic (In)stability under Balanced-Budget Rules," Working Papers 0701, Barnard College, Department of Economics.
  12. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
  13. Stephanie Schmitt-Grohe & Martin Uribe, 1995. "Balanced-budget rules, distortionary taxes, and aggregate instability," Finance and Economics Discussion Series 95-44, Board of Governors of the Federal Reserve System (U.S.).
  14. Stefano Bosi & Thomas Seegmuller, 2006. "Can heterogeneous preferences stabilize endogenous fluctuations ?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00130200, HAL.
  15. Zhang, Yan & Chen, Yan, 2009. "Endogenous income taxes in OLG economies," MPRA Paper 16412, University Library of Munich, Germany.
  16. Thomas Seegmuller, 2003. "Endogenous fluctuations and public services in a simple OLG economy," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-7.
  17. Bosi, Stefano & Seegmuller, Thomas, 2010. "On the role of progressive taxation in a Ramsey model with heterogeneous households," Journal of Mathematical Economics, Elsevier, vol. 46(6), pages 977-996, November.
  18. repec:ebl:ecbull:v:5:y:2003:i:10:p:1-7 is not listed on IDEAS
  19. Sarte, Pierre-Daniel G., 1997. "Progressive taxation and income inequality in dynamic competitive equilibrium," Journal of Public Economics, Elsevier, vol. 66(1), pages 145-171, October.
  20. Guo, Jang-Ting & Harrison, Sharon G., 2004. "Balanced-budget rules and macroeconomic (in)stability," Journal of Economic Theory, Elsevier, vol. 119(2), pages 357-363, December.
  21. Woodford, Michael, 1986. "Stationary sunspot equilibria in a finance constrained economy," Journal of Economic Theory, Elsevier, vol. 40(1), pages 128-137, October.
  22. repec:hal:journl:halshs-00266713 is not listed on IDEAS
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  24. Becker, Robert A, 1980. "On the Long-Run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households," The Quarterly Journal of Economics, MIT Press, vol. 95(2), pages 375-82, September.
  25. R. A. Musgrave & Tun Thin, 1948. "Income Tax Progression, 1929-48," Journal of Political Economy, University of Chicago Press, vol. 56, pages 498.
  26. Reichlin, Pietro, 1986. "Equilibrium cycles in an overlapping generations economy with production," Journal of Economic Theory, Elsevier, vol. 40(1), pages 89-102, October.
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