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Progressive Taxation and Monetary Policy in a Currency Union

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  • Strehl, Wolfgang
  • Engler, Philipp

Abstract

We analyse the welfare properties of progressive income taxes in a stylized DSGE model of a currency union calibrated to the Eurozone. When the central bank follows a standard Taylor rule and volatility originates solely in productivity shocks, we find that considerable welfare gains can be achieved by introducing a progressive income tax schedule. The reason is that the slightly lower average levels of consumption and greater volatility of hours are more than offset in their effects on welfare by a significant reduction in consumption volatility. However, at the aggregate level this result is not robust to the introduction of rule-of-thumb households, but we find a positive welfare effect for the latter type of households while intertemporally optimizing households lose. Furthermore, under an optimal monetary policy, welfare falls even in the absence of rule-of-thumb households. When demand shocks are considered, progressive taxes cannot improve welfare. Increasing tax progression above the Eurozone average is a "beggar-thyself" policy for all specifications.

Suggested Citation

  • Strehl, Wolfgang & Engler, Philipp, 2015. "Progressive Taxation and Monetary Policy in a Currency Union," Annual Conference 2015 (Muenster): Economic Development - Theory and Policy 112823, Verein für Socialpolitik / German Economic Association.
  • Handle: RePEc:zbw:vfsc15:112823
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    References listed on IDEAS

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    1. Bernd Hayo & Boris Hofmann, 2006. "Comparing monetary policy reaction functions: ECB versus Bundesbank," Empirical Economics, Springer, vol. 31(3), pages 645-662, September.
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    JEL classification:

    • F45 - International Economics - - Macroeconomic Aspects of International Trade and Finance - - - Macroeconomic Issues of Monetary Unions
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy

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