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Are Progressive Fiscal Rules Stabilizing?

Author

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  • Nicolas Dromel

    () (CES - Centre d'économie de la Sorbonne - UP1 - Université Panthéon-Sorbonne - CNRS - Centre National de la Recherche Scientifique)

  • Patrick-Antoine Pintus

    () (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - ECM - Ecole Centrale de Marseille - CNRS - Centre National de la Recherche Scientifique - AMU - Aix Marseille Université - EHESS - École des hautes études en sciences sociales)

Abstract

This paper studies how income-based, progressive taxes and transfers may reduce aggregate volatility by protecting the economy against expectation-driven business cycles. Eliminating “local” sunspots that are arbitrarily close to an indeterminate steady state requires, for sensible parameter values, strong levels of progressivity so as to make labor supply close to inelastic. However, progressive taxes and transfers are shown to be ineffective to rule out stable deterministic cycles (and the associated “global” sunspots) that are located close to a determinate steady state. Our results are formalized within two benchmark models and show how the efficiency of progressive fiscal schemes as local automatic stabilizers depends on the fiscal base. In the first setting with heterogeneous agents and segmented asset markets in which wage income mostly finances consumption, we show that progressive taxes and transfers should be made dependent on labor income, so as to rule out local indeterminacy. On the contrary, progressive fiscal rules should be applied to capital income in an overlapping generations economy where consumption comes from savings income. Incidentally, the latter results suggest that capital income taxes may be desirable, when progressive, to make local expectation-driven fluctuations less likely. In both frameworks, key to the results is the property that progressive fiscal rules provide insurance in the presence of imperfect capital markets.

Suggested Citation

  • Nicolas Dromel & Patrick-Antoine Pintus, 2006. "Are Progressive Fiscal Rules Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00410452, HAL.
  • Handle: RePEc:hal:cesptp:halshs-00410452
    Note: View the original document on HAL open archive server: https://halshs.archives-ouvertes.fr/halshs-00410452
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    References listed on IDEAS

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    1. 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.
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    3. Guo, Jang-Ting & Lansing, Kevin J., 1998. "Indeterminacy and Stabilization Policy," Journal of Economic Theory, Elsevier, vol. 82(2), pages 481-490, October.
    4. Steven P. Cassou & Kevin J. Lansing, 2004. "Growth Effects of Shifting from a Graduated-rate Tax System to a Flat Tax," Economic Inquiry, Western Economic Association International, vol. 42(2), pages 194-213, April.
    5. Lansing, Kevin J., 1999. "Optimal redistributive capital taxation in a neoclassical growth model," Journal of Public Economics, Elsevier, vol. 73(3), pages 423-453, September.
    6. Saez, Emmanuel, 2013. "Optimal progressive capital income taxes in the infinite horizon model," Journal of Public Economics, Elsevier, vol. 97(C), pages 61-74.
    7. Persson, Mats, 1983. "The distribution of abilities and the progressive income tax," Journal of Public Economics, Elsevier, vol. 22(1), pages 73-88, October.
    8. Kemp, Murray C & Long, Ngo Van & Shimomura, Koji, 1993. "Cyclical and Noncyclical Redistributive Taxation," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 34(2), pages 415-429, May.
    9. Dromel, Nicolas L. & Pintus, Patrick A., 2007. "Linearly progressive income taxes and stabilization," Research in Economics, Elsevier, vol. 61(1), pages 25-29, March.
    10. Englund, Peter & Persson, Mats, 1982. "Housing prices and tenure choice with asymmetric taxes and progressivity," Journal of Public Economics, Elsevier, vol. 19(3), pages 271-290, December.
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    13. Grandmont, Jean-Michel & Pintus, Patrick & de Vilder, Robin, 1998. "Capital-Labor Substitution and Competitive Nonlinear Endogenous Business Cycles," Journal of Economic Theory, Elsevier, vol. 80(1), pages 14-59, May.
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    15. Elizabeth M. Caucutt & Selahattin Imrohoroglu & Krishna B. Kumar, 2003. "Growth and Welfare Analysis of Tax Progressivity in a Heterogeneous-Agent Model," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 6(3), pages 546-577, July.
    16. Robert A. Becker, 1980. "On the Long-Run Steady State in a Simple Dynamic Model of Equilibrium with Heterogeneous Households," The Quarterly Journal of Economics, Oxford University Press, vol. 95(2), pages 375-382.
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    Cited by:

    1. Dromel, Nicolas L. & Pintus, Patrick A., 2007. "Linearly progressive income taxes and stabilization," Research in Economics, Elsevier, vol. 61(1), pages 25-29, March.
    2. repec:mje:mjejnl:v:10:y:2014:i:2:p:49-61 is not listed on IDEAS
    3. Mohanad Ismael, 2010. "Progressive income taxes and macroeconomic instability," Documents de recherche 10-13, Centre d'Études des Politiques Économiques (EPEE), Université d'Evry Val d'Essonne.
    4. Seiya Fujisaki & Kazuo Mino, 2008. "Income Taxation, Interest-Rate Control and Macroeconomic Stability with Balanced-Budget," Discussion Papers in Economics and Business 08-20, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    5. Daniel R. Carroll & Eric R. Young, 2009. "A note on sunspots with heterogeneous agents," Working Paper 0906, Federal Reserve Bank of Cleveland.

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