Hostname: page-component-cd9895bd7-gvvz8 Total loading time: 0 Render date: 2024-12-23T19:33:23.013Z Has data issue: false hasContentIssue false
  • English
  • Français

CREDIT FRICTIONS AND OPTIMAL LABOR-INCOME TAXATION

Published online by Cambridge University Press:  25 January 2018

Salem Abo-Zaid
Salem Abo-Zaid*
Affiliation:
Texas Tech University
*
Address correspondence to: Salem Abo-Zaid, Department of Economics, Texas Tech University, P.O. Box 41014, Lubbock, TX 79409, USA; e-mail: [email protected].
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper studies optimal labor-income taxation in a simple model with credit constraints on firms. The labor-income tax rate and the shadow value on the credit constraint induce a wedge between the marginal product of labor and the marginal rate of substitution between labor and consumption. It is found that optimal policy prescribes a volatile path for the labor-income tax rate even in the presence of state-contingent debt and capital. In this respect, credit frictions are akin to a form of market incompleteness. Credit frictions break the equivalence between tax smoothing and wedge smoothing; therefore, as the tightness of the credit constraint varies over the business cycle, tax volatility is needed in order to counter this variation and, as a result, allow for wedge smoothing.

Keywords

Labor-Income Tax SmoothingCredit FrictionsStatic Wedge
Type
Articles
Information
Macroeconomic Dynamics , Volume 23 , Issue 7 , October 2019 , pp. 2845 - 2891
Copyright
Copyright © Cambridge University Press 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

I am grateful to William A. Barnett (the editor), the associate editor and two anonymous referees for very invaluable comments and suggestions.

References

REFERENCES

Aiyagari, Rao S. (1995) Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting. Journal of Political Economy 103, 1158–1175.10.1086/601445Google Scholar
Aiyagari, Rao S., Marcet, Albert, Sargent, Thomas J., and Seppala, Juha (2002) Optimal taxation without state-contingent debt. Journal of Political Economy 110, 1220–1254.10.1086/343744Google Scholar
Angeletos, George-Marios (2002) Fiscal policy with noncontingent debt and the optimal maturity structure. Quarterly Journal of Economics 117, 1105–1131.10.1162/003355302760193977Google Scholar
Andersen, Torben M. and Dogonowski, Robert R. (2004) What should optimal income taxes smooth? Journal of Public Economic Theory 6, 491–507.10.1111/j.1467-9779.2004.00176.xGoogle Scholar
Arbex, Marcelo and O'Dea, Dennis (2014) Optimal taxation and social networks. Macroeconomic Dynamics 18, 1683–1712.10.1017/S1365100513000096Google Scholar
Arseneau, David M. and Chugh, Sanjay K. (2012) Tax smoothing in frictional labor markets. Journal of Political Economy 120, 926–985.10.1086/668837Google Scholar
Barro, Robert (1979) On the determination of public debt. Journal of Political Economy 87, 940–971.10.1086/260807Google Scholar
Beck, Thorsten, Demirguc-Kunt, Asli, and Maksimovic, Vojislav (2005) Financial and legal constraints to growth: Does firm size matter? Journal of Finance 60, 137–177.10.1111/j.1540-6261.2005.00727.xGoogle Scholar
Campello, Murillo, Graham, John R., and Harvey, Campbell R. (2010) The real effects of financial constraints: Evidence from a financial crisis. Journal of Financial Economics 97, 470–487.10.1016/j.jfineco.2010.02.009Google Scholar
Carlstrom, Charles T. and Fuerst, Timothy S. (1998) Agency costs and business cycles. Economic Theory 12, 583–597.10.1007/s001990050236Google Scholar
Carlstrom, Charles T., Fuerst, Timothy S., and Paustian, Matthias (2010) Optimal monetary policy in a model with agency costs. Journal of Money, Credit and Banking 42 (s1), 37–70.10.1111/j.1538-4616.2010.00329.xGoogle Scholar
Chahrour, Ryan and Justin, Svec (2014) Optimal capital taxation and consumer uncertainty. Journal of Macroeconomics 41, 178–198.10.1016/j.jmacro.2014.06.001Google Scholar
Chamley, Christophe (1986) Optimal taxation of capital income in general equilibrium with infinite lives. Econometrica 54, 607–622.10.2307/1911310Google Scholar
Chaney, Thomas, Sraer, David, and Thesmar, David (2012) The collateral channel: How real estate shocks affect corporate investment. American Economic Review 102, 2381–2409.10.1257/aer.102.6.2381Google Scholar
Chari, V. V., Christiano, Larwrence, and Kehoe, Patrick (1994) Optimal fiscal policy in a business cycle model. Journal of Political Economy 102, 617–652.10.1086/261949Google Scholar
Chari, V. V. and Kehoe, Patrick (1999) Optimal fiscal and monetary policy. In Taylor, John B. and Woodford, Michael (eds.), Handbook of Macroeconomics, vol. 1, pp. 1671–1745. Amsterdam, Netherlands: North-Holland.10.1016/S1574-0048(99)10039-9Google Scholar
Chugh, Sanjay K. (2009) Does the timing of the cash-in-advance constraint matter for optimal fiscal and monetary policy? Macroeconomic Dynamics 13, 133–150.10.1017/S1365100509080158Google Scholar
Cooley, Thomas F. and Prescott, Edward C. (1995) Economic growth and business cycles. In Cooley, Thomas F. (ed.), Frontiers of Business Cycle Research, pp. 1–38. Princeton, NJ: Princeton University Press.Google Scholar
De Paoli, Bianca and Paustian, Matthias (2013) Coordinating Monetary and Macroprudential Policies. Federal Reserve Bank of New York Staff Reports, Number 653, Federal Reserve Bank of New York, New York, NY.Google Scholar
Gerali, Andrea, Neri, Stefano, Sessa, Luca, and Signoretti, Federico M. (2010) Credit and banking in a DSGE model of the Euro area. Journal of Money, Credit and Banking 42 (s1), 107–141.10.1111/j.1538-4616.2010.00331.xGoogle Scholar
Guerrieri, Luca and Iacoviello, Matteo (2015) OccBin: A toolkit for solving dynamic models with occasionally binding constraints easily. Journal of Monetary Economics 70, 22–38.10.1016/j.jmoneco.2014.08.005Google Scholar
Guo, Jang-Ting and Lansing, Kevin J. (1999) Optimal taxation of capital income with imperfectly competitive product markets. Journal of Economic Dynamics and Control 23, 967–995.10.1016/S0165-1889(98)00047-5Google Scholar
Hagedorn, Marcus (2010) Ramsey tax cycles. Review of Economic Studies 77, 1042–1071.10.1111/j.1467-937X.2009.00592.xGoogle Scholar
Harding, John P., Rosenthal, Stuart S., and Sirmans, C. F. (2007) Depreciation of housing capital, maintenance, and house price inflation: Estimates from a repeat sales model. Journal of Urban Economics 61, 193–217.10.1016/j.jue.2006.07.007Google Scholar
Iacoviello, Matteo (2005) House prices, borrowing constraints and monetary policy in the business cycle. American Economic Review 95, 739–764.10.1257/0002828054201477Google Scholar
Jermann, Urban and Quadrini, Vincenzo (2012) Macroeconomic effects of financial shocks. American Economic Review 102, 238–271.10.1257/aer.102.1.238Google Scholar
Judd, Kenneth (1985) Redistributive taxation in a simple perfect foresight model. Journal of Public Economics 28, 59–83.10.1016/0047-2727(85)90020-9Google Scholar
Kiyotaki, Nobuhiro and Moore, John (1997) Credit cycles. Journal of Political Economy 105, 211–248.10.1086/262072Google Scholar
Lucas, Robert E. and Stokey, Nancy L. (1983) Optimal fiscal and monetary policy in an economy without capital. Journal of Monetary Economics 12, 55–93.10.1016/0304-3932(83)90049-1Google Scholar
Monacelli, Tommaso (2008) Optimal monetary policy with collateralized household debt and borrowing constraints. In Campbell, John Y. (ed.), Asset Prices and Monetary Policy, pp. 103–146. Chicago, IL: The University of Chicago Press.10.7208/chicago/9780226092126.003.0004Google Scholar
Reis, Catarina (2011) Entrepreneurial labor and capital taxation. Macroeconomic Dynamics 15, 326–335.10.1017/S1365100510000039Google Scholar
Schmitt-Grohe, Stephanie and Uribe, Martin (2004) Optimal fiscal and monetary policy under sticky prices. Journal of Economic Theory 114, 198–230.10.1016/S0022-0531(03)00111-XGoogle Scholar
Svensson, Lars E. O. (1985) Money and asset prices in a cash-in-advance economy. Journal of Political Economy 93, 919–944.Google Scholar