Income Taxation Rules and Stability of a Small Open Economy |
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| Institution: | 1. Institute of Economics, Academia Sinica, 128 Academia Road, Section 2, Taipei, Taiwan;2. Graduate School of Economics, Kobe University, 2-1 Rokodai-cho, Nada-ku, Kobe 657-8501, Japan;3. Institute of Economic Research, Kyoto University, Yoshida Honmachi, Sakyo-ku, Kyoto, 606-850 Japan;1. Department of Quantitative Economics, School of Business and Economics, Maastricht University, Maastricht, The Netherlands;2. Faculty of Economics and Business, University of Groningen, PO Box 800, 9700 AV, Groningen, The Netherlands;3. University of Tasmania, Australia;4. CAMA, Australia;5. CIRANO, Canada;6. Management School, University of Liverpool, Liverpool, UK;1. Department of Economics, Vanderbilt University, Nashville, TN 37235, USA;2. Department of Economics, Oregon State University, Corvallis, OR 97331, USA;3. School of Finance, Renmin University of China, Beijing 100872, China;1. European Central Bank, DG Monetary Policy, Italy;2. Sapienza University of Rome, Italy |
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| Abstract: | This paper examines the stability of a small open economy under alternative income taxation rules. Using a one-sector real business cycle model with external increasing returns, we show that if the income tax schedule is linear, the small open economy will not generate equilibrium indeterminacy, but it exhibits a diverging behavior under certain conditions. In this case, an appropriate choice of nonlinear tax on the factor income may recover the saddle-point stability. We also reveal that if the taxation on the interest income on financial assets is regressive, then the small open economy may exhibit equilibrium indeterminacy. In this situation, a progressive tax rule on the interest income can contribute to eliminating sunspot-driven fluctuations. |
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