Taxes and stabilization in contemporary macroeconomic models |
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Authors: | Kenneth Kletzer |
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Institution: | (1) Department of Economics, University of California, Santa Cruz, CA, 95064 |
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Abstract: | The role of proportional and procyclic labor income taxes for automatic stabilization with stochastic productivity is analyzed
in a contemporary macroeconomic model based on imperfect competition. The importance of short-run nominal wage rigidity for
the effectiveness of progressive taxes on labor income for stabilizing output and raising household welfare is examined in
a model that yields complete analytical solutions with stochastic output shocks. Increasing the procyclicity of labor income
tax rates raises welfare with and without rigid nominal wages in the model economy. With fully flexible prices and wages,
a positive covariance between the distortionary tax rate and productivity reduces the volatility of production and employment.
This effect disappears under nominal wage rigidity, although progressive taxation can still raise welfare by reducing the
distortion caused by a proportional labor tax. With rigid nominal wages and flexible consumer goods prices, payroll taxes
levied at rates that rise with output can serve as automatic stabilizers.
JEL Code E62 · H20 |
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Keywords: | Taxes Productivity shocks Nominal rigidities Macroeconomic stabilization |
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