Abo-Zaid, Salem (2012): Optimal labor-income tax volatility with credit frictions.
Download (503Kb) | Preview
This paper studies the optimality of labor tax smoothing in a simple model with credit frictions. Firms’ borrowing to pay their wage payments in advance is constrained by the value of their collateral at the beginning of the period. The labor tax and the shadow value on the credit constraint lead to a (static) wedge between the marginal product of labor and the marginal rate of substitution between labor and consumption. This paper suggests that while the notion of “wedge smoothing” is carried over to this environment, it is achieved only through a volatile labor-income tax rate. As the shadow value on the financing constraint varies over the business cycle, tax volatility is needed in order to counteract this variation and thus allow for “wedge smoothing”. In particular, the optimal labor-income tax rate is lower when the credit market is more tightened and higher when the credit market is less tightened. Therefore, when firms are more credit-constrained and the demand for labor is reduced, optimal fiscal policy calls for boosting labor supply by lowering the labor-income tax rate.
|Item Type:||MPRA Paper|
|Original Title:||Optimal labor-income tax volatility with credit frictions.|
|English Title:||Optimal Labor-Income Tax Volatility with Credit Frictions.|
|Keywords:||Labor tax smoothing; Credit frictions; Borrowing constraints|
|Subjects:||E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, Macroeconomic Policy, and General Outlook > E62 - Fiscal Policy
H - Public Economics > H2 - Taxation, Subsidies, and Revenue > H21 - Efficiency; Optimal Taxation
E - Macroeconomics and Monetary Economics > E4 - Money and Interest Rates > E44 - Financial Markets and the Macroeconomy
|Depositing User:||Salem Abo-Zaid|
|Date Deposited:||28. May 2012 23:31|
|Last Modified:||21. Feb 2013 21:26|
Aiyagari S.R., Marcet A., Sargent T., Seppala J. (2002) “Optimal Taxation without State-Contingent Debt.”Journal of Political Economy, Vol. 110, pp. 1220-1254.
Arseneau D. and Chugh S. (2010) “Tax Smoothing in Frictional Labor Markets.” Mimeo, University of Maryland.
Barro R. (1979) “On the Determination of Public Debt.” Journal of Political Economy, Vol. 87, pp. 940-971.
Carlstrom C. and Fuerst T. (1997) “Agency Costs, Net Worth, and Business Fluctuations: A Computable General Equilibrium Analysis.” American Economic Review, Vol. 87, pp. 893-910.
Carlstrom C. and Fuerst T. (1998) “Agency Costs and Business Cycles.” Economic Theory, Vol. 12, pp. 583-597.
Carlstrom C., Fuerst T. and Paustian M. (2010) “Optimal Monetary Policy in a Model with Agency Costs.” Journal of Money, Credit and Banking, Vol. 42, Issue Supplement, pp. 37-70.
Chaney T., Sraer D. and Thesmar D. (2011) “The Collateral Channel: How Real Estate Shocks Affect Corporate Investment.” American Economic Review, forthcoming.
Chari, V. V., Christiano L., and Kehoe P. (1991) “Optimal Fiscal and Monetary Policy: Some Recent Results.” Journal of Money, Credit and Banking, Vol. 23, pp. 519–539.
Chari, V. V., Christiano L., and Kehoe P. (1994) “Optimal Fiscal Policy in a Business Cycle Model.” Journal of Political Economy, Vol. 102, pp. 617–52.
Chari, V. V. and Kehoe P. (1999) “Optimal Fiscal and Monetary Policy." Handbook of Macroeconomics, J. B. Taylor and Woodford M. (ed.), Vol. 1, pp. 1671-1745.
Iacoviello M. (2005) “House Prices, Borrowing Constraints and Monetary Policy in the Business Cycle.” American Economic Review, Vol. 95, pp. 739-764.
Kiyotaki N. and Moore J. (1997) “Credit Cycles.” Journal of Political Economy, Vol. 105, pp. 211-248.
Lucas R. and Stokey N. (1983) “Optimal Fiscal and Monetary Policy in an Economy without Capital.” Journal of Monetary Economics, Vol. 12, pp.55-93.
Schmitt-Grohe S. and Uribe M. (2004a) “Optimal Fiscal and Monetary Policy under Sticky Prices. Journal of Economic Theory 114, 198-230.
Schmitt-Grohe S. and Uribe M. (2004b) “Solving Dynamic General Equilibrium Models Using a Second-Order Approximation to the Policy Function,” Journal of Economic Dynamics and Control, Vol. 28, pp. 755-775.