Working Paper: CEPR ID: DP5531
Authors: Chryssi Giannitsarou
Abstract: It is known that, in the context of a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise as a result of endogenous labor income tax rates. In this paper, it is shown that when the government finances its expenditures via an endogenous consumption tax instead, there exists a unique steady state which is always saddle-path stable. As a result, combining income taxes with consumption taxes makes the ranges of indeterminacy shrink, thus reducing the possibility of aggregate instability. From a policy perspective, the results provide an additional argument in favor of (less distortionary) consumption taxes in place of capital taxes.
Keywords: balanced budget rules; consumption tax; fiscal policy; indeterminacy
JEL Codes: C62; E62
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Consumption taxes (H29) | Economic stability (E60) |
| Income taxes (H29) | Indeterminacy (D89) |
| Consumption taxes + endogenous income taxes (H29) | Reduced likelihood of aggregate instability (E19) |
| Higher consumption tax rates (H29) | Reduced ranges of indeterminacy (D80) |