Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes

13 Pages Posted: 26 Sep 2007

See all articles by Chryssi Giannitsarou

Chryssi Giannitsarou

University of Cambridge - Faculty of Economics; Centre for Economic Policy Research (CEPR)

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Abstract

It is known that in a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise due to endogenous labour income tax rates. This article shows that when the government finances its expenditures via an endogenous consumption tax instead, a steady state is always saddle-path stable. Consequently, combining income taxes with consumption taxes makes the ranges of indeterminacy shrink, thus reducing the possibility of aggregate instability. From a policy perspective, the results provide an additional argument in favour of consumption taxes in place of capital taxes.

Suggested Citation

Giannitsarou, Chryssi, Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes. Economic Journal, Vol. 117, No. 523, pp. 1423-1435, October 2007. Available at SSRN: https://ssrn.com/abstract=1017123 or http://dx.doi.org/10.1111/j.1468-0297.2007.02089.x

Chryssi Giannitsarou (Contact Author)

University of Cambridge - Faculty of Economics ( email )

Austin Robinson Building
Sidgwick Avenue
Cambridge, CB3 9DD
United Kingdom

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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