On Indeterminacy and Growth under Progressive Taxation and Utility‐Generating Government Spending

• DOI: http://doi.org/10.1111/1468-0106.12210
• Author: Shu‐Hua Chen,Jang‐Ting Guo
• Date: 01 August 2018
• Published date: 01 August 2018

Pacific Economic Review,••:•• (2016) pp. 1-29

doi: 10.1111/1468-0106.12135

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ON INDETERMINACY AND GROWTH UNDER

PROGRESSIVE TAXATION AND UTILITY-GENERATING

GOVERNMENT SPENDING

SHU-HUA CHEN National Taipei University

JANG-TING GUO*University of California

Abstract. We examine the theoretical interrelations between progressive income taxation and mac-

roeconomic (in)stability in an otherwise standard one-sector AK model of endogenous growth with

utility-generating government purchases of goods and services. In sharp contrast to traditional

Keynesian-type stabilization policies, progressive taxation operates like an automatic destabilizer

that generates equilibrium indeterminacy and belief-driven fluctuations in our endogenously growing

macroeconomy. Unlike the no-sustained-growth counterpart, this instability result is obtained re-

gardless of (i) the degree of the public-spending preference externality and (ii) whether private and

public consumption expenditures are substitutes, complements or additively separable in the house-

hold’s utility function.

1. INTRODUCTION

Starting with the important works of Jones and Manuelli (1990), King and

Rebelo (1990) and Rebelo (1991), substantial progress has been made in explor-

ing the aggregate effects of various fiscal policies within an endogenously grow-

ing macroeconomy. As it turns out, many existing theoretical studies consider a

constant tax rate of income and/or useless government purchases of goods and

services that do not contribute to utility or production.1Although these as-

sumptions are commonly adopted for the sake of analytical simplicity, they

are not consistent with those observed in the actual data. Motivated by this

gap in the previous literature, we examine a parsimonious one-sector endoge-

nous growth model with progressive/regressive taxation of income and utility-

generating public expenditures. Specifically, the present paper analytically

investigates the interrelations between sustained economic growth, equilibrium

(in)determinacy and tax progressivity/regressivity governed by a single parame-

ter. As a result, the current piece complements our earlier work, as in Chen and

*Address for Correspondence: Department of Economics, University of California, Riverside, 3133

Sproul Hall, CA 92521, USA. E-mail: guojt@ucr.edu. We thank David Cook (Editor), an Associate

Editor, an anonymous referee, Juin-Jen Chang, Been-Lon Chen, Hung-Ju Chen, Yunfang Hu, Shun-

Fa Lee, Ching-Chong Lai, Yiting Li, David Malueg, Kazuo Mino, Victor Ortego-Marti, Cheng

Wang, Yan Zhang and seminar participants at the National Tsing Hua University, the National

Taiwan University, the University of Hong Kong, Academia Sinica, Kobe University and the An-

nual Meeting of the Taiwan Economic Association for helpful comments and suggestions. Part of

this research was conducted while Guo was a visiting research fellow of economics at Academia

Sinica, Taipei, Taiwan, whose hospitality is greatly appreciated.

1See, for example, Barro and Sala-i-Martin (1992), Futagami et al. (1993), Pecorino (1993), Glomm

and Ravikumar (1994, 1997), Cazzavillan (1996), Turnovsky (1996, 1997, 1999), Zhang (2000), Baier

and Glomm (2001), Yamarik (2001), Palivos et al. (2003), Chen (2006), Greiner (2007) and Hu et al.

(2008), among others.

Pacific Economic Review,••:•• (2017)

doi: 10.1111/1468-0106.12210

© 2017 John Wiley & Sons Australia, Ltd

© 2017 John Wiley & Sons Australia, Ltd

Pacific Economic Review

, 23: 3 (2018) pp. 533–543

doi:10.1111/1468-0106.12210