Progressive Taxation as an Automatic Stabilizer under Nominal Wage Rigidity and Preference Shocks

Miroslav Gabrovski and Jang-Ting Guo

No 202004, Working Papers from University of California at Riverside, Department of Economics

Abstract: Previous research has shown that in the context of a prototypical New Keynesian model, more progressive income taxation may lead to higher volatilities of hours worked and total output in response to a monetary disturbance. We analytically show that this business-cycle destabilization result is overturned within an otherwise identical macroeconomy subject to impulses to the household's utility formulation. Under a continuously or linearly progressive fiscal policy rule, an increase in the tax progressivity will always raise the degree of equilibrium nominal-wage rigidity, and thus serve as an automatic stabilizer that mitigates cyclical fluctuations driven by preference shocks. Our analysis illustrates that whether a more progressive tax schedule (de)stabilizes the business cycle depends crucially on the underlying driving source.

Keywords: Progressive Income Taxation; Automatic Stabilizer; Nominal Wage Rigidity; Preference Shocks. (search for similar items in EconPapers)
JEL-codes: E12 E32 E62 (search for similar items in EconPapers)
Date: 2020-03
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe, nep-pub and nep-upt
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https://economics.ucr.edu/repec/ucr/wpaper/202004.pdf First version, 2020 (application/pdf)

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Journal Article: Progressive taxation as an automatic stabilizer under nominal wage rigidity and preference shocks (2022)
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