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Progressive income taxes and macroeconomic instability

  • Ismael, Mohanad

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 University Library of Munich, Germany in its series MPRA Paper with number 49917.

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Date of creation: 28 Mar 2011
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Handle: RePEc:pra:mprapa:49917
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  1. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
  2. 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.
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  4. Nicolas Dromel & Patrick-Antoine Pintus, 2007. "Linearly Progressive Income Taxes and Stabilization," Post-Print halshs-00641124, HAL.
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  8. 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.).
  9. 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.
  10. Lloyd-Braga, Teresa & Modesto, Leonor & Seegmuller, Thomas, 2006. "Tax Rate Variability and Public Spending as Sources of Inderterminacy," CEPR Discussion Papers 5796, C.E.P.R. Discussion Papers.
  11. Cazzavillan, Guido & Lloyd-Braga, Teresa & Pintus, Patrick A., 1998. "Multiple Steady States and Endogenous Fluctuations with Increasing Returns to Scale in Production," Journal of Economic Theory, Elsevier, vol. 80(1), pages 60-107, May.
  12. Nicolas Dromel & Patrick-Antoine Pintus, 2008. "Are Progressive Income Taxes Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00640857, HAL.
  13. Chen, Yan & Zhang, Yan, 2009. "Endogenous income taxes in OLG economies: A clarification," MPRA Paper 16824, University Library of Munich, Germany.
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  17. Guo, Jang-Ting, 1999. "Multiple equilibria and progressive taxation of labor income," Economics Letters, Elsevier, vol. 65(1), pages 97-103, October.
  18. Nicolas Dromel & Patrick-Antoine Pintus, 2006. "Are Progressive Fiscal Rules Stabilizing?," Université Paris1 Panthéon-Sorbonne (Post-Print and Working Papers) halshs-00410452, HAL.
  19. 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.
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  21. 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.
  22. Woodford, Michael, 1986. "Stationary sunspot equilibria in a finance constrained economy," Journal of Economic Theory, Elsevier, vol. 40(1), pages 128-137, October.
  23. Thomas Seegmuller, 2003. "Endogenous fluctuations and public services in a simple OLG economy," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-7.
  24. 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.
  25. 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.
  26. R. A. Musgrave & Tun Thin, 1948. "Income Tax Progression, 1929-48," Journal of Political Economy, University of Chicago Press, vol. 56, pages 498.
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