Aggregate Instability under Labor Income Taxation and Balanced-Budget Rules: Preferences Matter

Nicolas Abad (1) , Thomas Seegmuller (1) , Alain Venditti (1, 2)

1 GREQAM - Groupement de Recherche en Économie Quantitative d'Aix-Marseille
2 EDHEC Business School

We investigate the role of preferences in the existence of expectation-driven instability under a balanced budget rule where government spendings are financed by a tax on labor income. Considering a one-sector neoclassical growth model with a large class of preferences, we find that expectation-driven fluctuations are more likely when consumption and labor are Edgeworth substitutes. Under this property, an intermediate range of tax rates and a sufficiently low elasticity of intertemporal substitution in consumption lead to instability. Numerical simulations of the model support the conclusion that labor income taxation is a plausible source of instability in most OECD countries.

Mots clés: indeterminacy; expectation-driven business cycles; infinite-horizon model; labor income taxes; balanced-budget rule

Domaines: Economies et finances

Nicolas Abad, Thomas Seegmuller, Alain Venditti. Aggregate Instability under Labor Income Taxation and Balanced-Budget Rules: Preferences Matter. 2013. ⟨halshs-00793213v2⟩