Stabilizing Competitive Cycles with Distortionary Taxation

28 Pages Posted: 7 Jun 2003

See all articles by Erkki Koskela

Erkki Koskela

University of Helsinki - Department of Political and Economic Studies; CESifo (Center for Economic Studies and Ifo Institute); Bank of Finland - Research Department; IZA Institute of Labor Economics

Mikko Puhakka

University of Oulu - Department of Economics

Date Written: May 2003

Abstract

We utilize a simple overlapping generations model with a balanced budget rule to study the effect of distortionary taxation on cycles and local stability of equilibria. We show that under proportional taxation there is a critical tax rate above which cycles will vanish, while in the case of linearly progressive taxation there is a critical level of exemption below which cycles will vanish as well. Hence, a sufficiently high tax rate and a low tax progression eliminate cycles. If the lifetime utility function is quasi-linear, increasing the tax rate can cause the economy to become locally unstable both with proportional and linearly progressive taxation so that tax exemption does not matter. Finally, if the lifetime utility function is not quasilinear, for small tax rates an increase in progression can locally destabilize the economy.

Keywords: Overlapping Generations, Cycles, Stabilizing Taxation

JEL Classification: D91, E32, H30

Suggested Citation

Koskela, Erkki and Puhakka, Mikko, Stabilizing Competitive Cycles with Distortionary Taxation (May 2003). CESifo Working Paper Series No. 947. Available at SSRN: https://ssrn.com/abstract=413868

Erkki Koskela (Contact Author)

University of Helsinki - Department of Political and Economic Studies ( email )

P.O. Box 54
FIN-00014 Helsinki
Finland
+358 9 191 8894 (Phone)
+358 9 191 8877 (Fax)

HOME PAGE: http://www.cesifo.de/servlet/page?_pageid=56&_dad=portal30&_schema=PORTAL30&pa_id=7298

CESifo (Center for Economic Studies and Ifo Institute)

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Munich, DE-81679
Germany

HOME PAGE: http://www.CESifo.de

Bank of Finland - Research Department ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Mikko Puhakka

University of Oulu - Department of Economics ( email )

PO Box 4600
FIN-90014 University of Oulu
Finland

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