Changes in the Composition of Tax Revenues: Implications for Monetary and Fiscal Policy

32 Pages Posted: 13 Jun 2022

See all articles by Pedro Gomis-Porqueras

Pedro Gomis-Porqueras

Deakin University

Solmaz Moslehi

Monash Business School

Xuan Zhou

Renmin University of China

Date Written: June 6, 2022

Abstract

This paper examines how the composition of tax revenues affects monetary and fiscal policy interactions. To do so, we consider an environment where households' wages and interest income as well as firms' profits are taxed. To implement policy, the government follows a Taylor rule and a fiscal rule that links tax revenues to public debt. The fiscal authority also sets the long-run debt to GDP ratio as well as the tax revenue composition. In this setting, both monetary and fiscal policies directly impact the demand for government liabilities. Thus, there is a direct channel through which fiscal policy affects inflation. As a result, the evolution of inflation and real debt are not independent of each other anymore. Because taxes are distortionary, there exists a Laffer curve potentially delivering multiple stationary equilibria. We also show that the composition of tax revenues is key in determining the combinations of monetary and fiscal policies that deliver locally determinate equilibria. When calibrated to the U.S. economy, we find that a lower contribution of corporate taxes to total tax revenues expands the parameter space consistent with a unique steady state. This is especially relevant for a high debt economy. Moreover, we find that a passive monetary and active fiscal policy mix is more likely to generate unique and desirable equilibria. Furthermore, the composition of tax revenues matters for dynamics for this policy regime.

Keywords: Taxes, Interest Income, Monetary and Fiscal Policy Interactions

JEL Classification: C11, E32, E62

Suggested Citation

Gomis-Porqueras, Pedro and Moslehi, Solmaz and Zhou, Xuan, Changes in the Composition of Tax Revenues: Implications for Monetary and Fiscal Policy (June 6, 2022). Available at SSRN: https://ssrn.com/abstract=4129538 or http://dx.doi.org/10.2139/ssrn.4129538

Pedro Gomis-Porqueras

Deakin University ( email )

Australia

Solmaz Moslehi

Monash Business School ( email )

Wellington Road
Clayton, Victoria 3168
Australia

Xuan Zhou (Contact Author)

Renmin University of China ( email )

Room B906
Xianjin Building
Beijing, Beijing 100872
China

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