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Optimal Fiscal Policy in a Business Cycle Model

  • V. V. Chari
  • Lawrence J. Christiano
  • Patrick J. Kehoe

This paper develops the quantitative implications of optimal fiscal policy in a business cycle model. In a stationary equilibrium the ex ante tax rate on capital income is approximately zero. There is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation. Within this class the optimal ex post capital tax rates can range from being close to i.i.d. to being close to a random walk. The tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks and thus there is no presumption that optimal labor tax rates follow a random walk. The welfare gains from smoothing labor tax rates and making ex ante capital income tax rates zero are small and most of the welfare gains come from an initial period of high taxation on capital income.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 4490.

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Date of creation: Oct 1993
Date of revision:
Publication status: published as Journal of Political Economy, vol. 102, no. 3, August 1994
Handle: RePEc:nbr:nberwo:4490
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  1. Christiano, Lawrence J & Eichenbaum, Martin, 1992. "Current Real-Business-Cycle Theories and Aggregate Labor-Market Fluctuations," American Economic Review, American Economic Association, vol. 82(3), pages 430-50, June.
  2. Edward C. Prescott, 1986. "Theory ahead of business cycle measurement," Staff Report 102, Federal Reserve Bank of Minneapolis.
  3. Pestieau, P. M., 1974. "Optimal taxation and discount rate for public investment in a growth setting," Journal of Public Economics, Elsevier, vol. 3(3), pages 217-235, August.
  4. Zhu, Xiaodong, 1992. "Optimal fiscal policy in a stochastic growth model," Journal of Economic Theory, Elsevier, vol. 58(2), pages 250-289, December.
  5. V. V. Chari & Lawrence J. Christiano & Patrick J. Kehoe, 1993. "Optimal fiscal policy in a business cycle model," Staff Report 160, Federal Reserve Bank of Minneapolis.
  6. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June.
  7. Thomas F. Cooley & Gary D. Hansen, 1991. "Tax distortions in a neoclassical monetary economy," Discussion Paper / Institute for Empirical Macroeconomics 38, Federal Reserve Bank of Minneapolis.
  8. Martin L. Weitzman, 1973. "Duality Theory for Infinite Horizon Convex Models," Management Science, INFORMS, vol. 19(7), pages 783-789, March.
  9. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-22, May.
  10. Kenneth L. Judd, 1982. "Redistributive Taxation in a Simple Perfect Foresight Model," Discussion Papers 572, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  11. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
  12. Christiano, Lawrence J., 1988. "Why does inventory investment fluctuate so much?," Journal of Monetary Economics, Elsevier, vol. 21(2-3), pages 247-280.
  13. Robert J. Barro & Chaipat Sahasakul, 1983. "Measuring the Average Marginal Tax Rate from the Individual Income Tax," NBER Working Papers 1060, National Bureau of Economic Research, Inc.
  14. Lucas, Robert Jr. & Stokey, Nancy L., 1983. "Optimal fiscal and monetary policy in an economy without capital," Journal of Monetary Economics, Elsevier, vol. 12(1), pages 55-93.
  15. Atkinson, A. B. & Stiglitz, J. E., 1972. "The structure of indirect taxation and economic efficiency," Journal of Public Economics, Elsevier, vol. 1(1), pages 97-119, April.
  16. Judd, Kenneth L., 1992. "Projection methods for solving aggregate growth models," Journal of Economic Theory, Elsevier, vol. 58(2), pages 410-452, December.
  17. Kydland, Finn E & Prescott, Edward C, 1982. "Time to Build and Aggregate Fluctuations," Econometrica, Econometric Society, vol. 50(6), pages 1345-70, November.
  18. Atkinson, A B & Sandmo, A, 1980. "Welfare Implications of the Taxation of Savings," Economic Journal, Royal Economic Society, vol. 90(359), pages 529-49, September.
  19. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  20. A. B. Atkinson, 1971. "Capital Taxes, the Redistribution of Wealth and Individual Savings," Review of Economic Studies, Oxford University Press, vol. 38(2), pages 209-227.
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  1. Quantitative Macroeconomics and Real Business Cycles (QM&RBC)

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