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

19 Pages Posted: 15 Jun 2006

See all articles by Chryssi Giannitsarou

Chryssi Giannitsarou

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

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Date Written: March 2006

Abstract

It is known that, in the context of a real business cycle model with constant returns to scale and a balanced budget fiscal policy rule, steady state indeterminacy may arise as a result of endogenous labor income tax rates. In this paper, it is shown that when the government finances its expenditures via an endogenous consumption tax instead, there exists a unique steady state which is always saddle-path stable. As a result, 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 favor of (less distortionary) consumption taxes in place of capital taxes.

Keywords: Fiscal policy, consumption tax, balanced budget rules, indeterminacy

JEL Classification: C62, E62

Suggested Citation

Giannitsarou, Chryssi, Balanced Budget Rules and Aggregate Instability: The Role of Consumption Taxes (March 2006). CEPR Discussion Paper No. 5531. Available at SSRN: https://ssrn.com/abstract=909264

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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