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Are Progressive Fiscal Rules Stabilizing?

  • Nicolas Dromel

    ()

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

  • Patrick-Antoine Pintus

    ()

    (GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille - Université Paul Cézanne - Aix-Marseille 3 - Université de la Méditerranée - Aix-Marseille 2 - EHESS - École des hautes études en sciences sociales - CNRS - AMU - Aix-Marseille Université)

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.

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Paper provided by HAL in its series Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) with number halshs-00410452.

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Date of creation: 2006
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Handle: RePEc:hal:cesptp:halshs-00410452
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  1. Michele Boldrin & Michael Horvath, 1994. "Labor Contracts and Business Cycles," Discussion Papers 1068, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  2. Kevin J. Lansing, 1998. "Optimal redistributive capital taxation in a neoclassical growth model," Working Papers in Applied Economic Theory 99-01, Federal Reserve Bank of San Francisco.
  3. 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.
  4. 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.
  5. Reichlin, Pietro, 1986. "Equilibrium cycles in an overlapping generations economy with production," Journal of Economic Theory, Elsevier, vol. 40(1), pages 89-102, October.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. Guo, Jang-Ting & Lansing, Kevin J., 1998. "Indeterminacy and Stabilization Policy," Journal of Economic Theory, Elsevier, vol. 82(2), pages 481-490, October.
  11. Persson, Mats, 1983. "The distribution of abilities and the progressive income tax," Journal of Public Economics, Elsevier, vol. 22(1), pages 73-88, October.
  12. Dromel, Nicolas L. & Pintus, Patrick A., 2007. "Linearly progressive income taxes and stabilization," Research in Economics, Elsevier, vol. 61(1), pages 25-29, March.
  13. 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 415-29, May.
  14. Emmanuel Saez, 2002. "Optimal Progressive Capital Income Taxes in the Infinite Horizon Model," NBER Working Papers 9046, National Bureau of Economic Research, Inc.
  15. 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.
  16. Stephenson, E. Frank, 1998. "Average marginal tax rates revisited," Journal of Monetary Economics, Elsevier, vol. 41(2), pages 389-409, April.
  17. Thomas Seegmuller & Leonor Modesto & Teresa Lloyd-Braga, 2008. "Market Imperfections and Endogenous Fluctuations," 2008 Meeting Papers 739, Society for Economic Dynamics.
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