Optimal Fiscal Policy in a Business Cycle Model
Varadarajan V. Chari
University of Minnesota - Twin Cities - Department of Economics; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)
Lawrence J. Christiano
Northwestern University; Federal Reserve Bank of Cleveland; Federal Reserve Bank of Chicago; Federal Reserve Bank of Minneapolis; National Bureau of Economic Research (NBER)
Patrick J. Kehoe
Federal Reserve Bank of Minneapolis - Research Department; University of Minnesota - Twin Cities - Department of Economics; National Bureau of Economic Research (NBER)
NBER Working Paper No. w4490
This paper develops the quantitative implications of optimal fiscal policy in a business cycle model. In a stationary equilibrium the ex ante tax rate on capital income is approximately zero. There is an equivalence class of ex post capital income tax rates and bond policies that support a given allocation. Within this class the optimal ex post capital tax rates can range from being close to i.i.d. to being close to a random walk. The tax rate on labor income fluctuates very little and inherits the persistence properties of the exogenous shocks and thus there is no presumption that optimal labor tax rates follow a random walk. The welfare gains from smoothing labor tax rates and making ex ante capital income tax rates zero are small and most of the welfare gains come from an initial period of high taxation on capital income.
Number of Pages in PDF File: 48
Date posted: April 11, 2011
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