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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 household's 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 aÌ uctuations. 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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  25. repec:hal:journl:halshs-00194395 is not listed on IDEAS
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