Working Paper: NBER ID: w5703
Authors: Lawrence J. Christian; Sharon G. Harrison
Abstract: We study a one-sector growth model which is standard except for the presence of an externality in the production function. The set of competitive equilibria is large. It includes constant equilibria, sunspot equilibria, cyclical and chaotic equilibria, and equilibria with deterministic or stochastic regime switching. The efficient allocation is characterized by constant employment and a constant growth rate. We identify an income tax-subsidy schedule that supports the efficient allocation as the unique equilibrium outcome. That schedule has two properties: (i) it specifies the tax rate to be an increasing function of aggregate employment, and (ii) earnings are subsidized when aggregate employment is at its efficient level. The first feature eliminates inefficient, fluctuating equilibria, while the second induces agents to internalize the externality.
Keywords: business cycles; self-fulfilling expectations; automatic stabilizers; tax policy
JEL Codes: E32; E63
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| tax rate (H25) | elimination of inefficient equilibria (D50) |
| earnings subsidized at efficient employment levels (J68) | agents induce to internalize the externality (D62) |
| tax system design (H20) | stabilize output at efficient level (E63) |