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Progressive Taxation and Macroeconomic (In)stability with Productive Government Spending

  • Jang-Ting Guo

    ()

    (Department of Economics, University of California Riverside)

  • Shu-Hua Chen

    ()

    (National Taipei University)

This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots only if the equilibrium wage-hours locus is positively sloped and steeper than the householdiÌs labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical aÌuctuations. Our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in U.S. output volatility after the Tax Reform Act of 1986 was implemented.

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File URL: http://economics.ucr.edu/repec/ucr/wpaper/10-06.pdf
File Function: First version, 2010
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Paper provided by University of California at Riverside, Department of Economics in its series Working Papers with number 201006.

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Date of creation: Aug 2010
Date of revision: Aug 2010
Handle: RePEc:ucr:wpaper:201006
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  7. James H. Stock & Mark W. Watson, 2003. "Understanding Changes in International Business Cycle Dynamics," NBER Working Papers 9859, National Bureau of Economic Research, Inc.
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  13. Benhabib, Jess & Nishimura, Kazuo, 1996. "Indeterminancy and Sunspots with Constant Returns," Working Papers 96-44, C.V. Starr Center for Applied Economics, New York University.
  14. Jang-Ting Guo & Kevin J. Lansing, 1997. "Indeterminacy and stabilization policy," Working Paper 9708, Federal Reserve Bank of Cleveland.
  15. 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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  17. Benhabib Jess & Farmer Roger E. A., 1994. "Indeterminacy and Increasing Returns," Journal of Economic Theory, Elsevier, vol. 63(1), pages 19-41, June.
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  19. David Aschauer, 1988. "Is public expenditure productive?," Staff Memoranda 88-7, Federal Reserve Bank of Chicago.
  20. 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.
  21. James A. Kahn & Margaret M. McConnell & Gabriel Perez-Quiros, 2002. "On the causes of the increased stability of the U.S. economy," Economic Policy Review, Federal Reserve Bank of New York, issue May, pages 183-202.
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  25. Gary Hansen, 2010. "Indivisible Labor and the Business Cycle," Levine's Working Paper Archive 233, David K. Levine.
  26. Benhabib, Jess & Farmer, Roger E.A., 1999. "Indeterminacy and sunspots in macroeconomics," Handbook of Macroeconomics, in: J. B. Taylor & M. Woodford (ed.), Handbook of Macroeconomics, edition 1, volume 1, chapter 6, pages 387-448 Elsevier.
  27. Christopher Giles & Paul Johnson, 1994. "Tax reform in the UK and changes in the progressivity of the tax system, 1985-95," Fiscal Studies, Institute for Fiscal Studies, vol. 15(3), pages 64-86, August.
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