Skip to main content
×
×
Home

CREDIT FRICTIONS AND OPTIMAL LABOR-INCOME TAXATION

  • Salem Abo-Zaid (a1)
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.

Copyright
Corresponding author
Address correspondence to: Salem Abo-Zaid, Department of Economics, Texas Tech University, P.O. Box 41014, Lubbock, TX 79409, USA; e-mail: salem.abozaid@ttu.edu.
Footnotes
Hide All

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

Footnotes
References
Hide All
Aiyagari, Rao S. (1995) Optimal capital income taxation with incomplete markets, borrowing constraints, and constant discounting. Journal of Political Economy 103, 11581175.
Aiyagari, Rao S., Marcet, Albert, Sargent, Thomas J., and Seppala, Juha (2002) Optimal taxation without state-contingent debt. Journal of Political Economy 110, 12201254.
Angeletos, George-Marios (2002) Fiscal policy with noncontingent debt and the optimal maturity structure. Quarterly Journal of Economics 117, 11051131.
Andersen, Torben M. and Dogonowski, Robert R. (2004) What should optimal income taxes smooth? Journal of Public Economic Theory 6, 491507.
Arbex, Marcelo and O'Dea, Dennis (2014) Optimal taxation and social networks. Macroeconomic Dynamics 18, 16831712.
Arseneau, David M. and Chugh, Sanjay K. (2012) Tax smoothing in frictional labor markets. Journal of Political Economy 120, 926985.
Barro, Robert (1979) On the determination of public debt. Journal of Political Economy 87, 940971.
Beck, Thorsten, Demirguc-Kunt, Asli, and Maksimovic, Vojislav (2005) Financial and legal constraints to growth: Does firm size matter? Journal of Finance 60, 137177.
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, 470487.
Carlstrom, Charles T. and Fuerst, Timothy S. (1998) Agency costs and business cycles. Economic Theory 12, 583597.
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), 3770.
Chahrour, Ryan and Justin, Svec (2014) Optimal capital taxation and consumer uncertainty. Journal of Macroeconomics 41, 178198.
Chamley, Christophe (1986) Optimal taxation of capital income in general equilibrium with infinite lives. Econometrica 54, 607622.
Chaney, Thomas, Sraer, David, and Thesmar, David (2012) The collateral channel: How real estate shocks affect corporate investment. American Economic Review 102, 23812409.
Chari, V. V., Christiano, Larwrence, and Kehoe, Patrick (1994) Optimal fiscal policy in a business cycle model. Journal of Political Economy 102, 617652.
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. 16711745. Amsterdam, Netherlands: North-Holland.
Chugh, Sanjay K. (2009) Does the timing of the cash-in-advance constraint matter for optimal fiscal and monetary policy? Macroeconomic Dynamics 13, 133150.
Cooley, Thomas F. and Prescott, Edward C. (1995) Economic growth and business cycles. In Cooley, Thomas F. (ed.), Frontiers of Business Cycle Research, pp. 138. Princeton, NJ: Princeton University Press.
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.
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), 107141.
Guerrieri, Luca and Iacoviello, Matteo (2015) OccBin: A toolkit for solving dynamic models with occasionally binding constraints easily. Journal of Monetary Economics 70, 2238.
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, 967995.
Hagedorn, Marcus (2010) Ramsey tax cycles. Review of Economic Studies 77, 10421071.
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, 193217.
Iacoviello, Matteo (2005) House prices, borrowing constraints and monetary policy in the business cycle. American Economic Review 95, 739764.
Jermann, Urban and Quadrini, Vincenzo (2012) Macroeconomic effects of financial shocks. American Economic Review 102, 238271.
Judd, Kenneth (1985) Redistributive taxation in a simple perfect foresight model. Journal of Public Economics 28, 5983.
Kiyotaki, Nobuhiro and Moore, John (1997) Credit cycles. Journal of Political Economy 105, 211248.
Lucas, Robert E. and Stokey, Nancy L. (1983) Optimal fiscal and monetary policy in an economy without capital. Journal of Monetary Economics 12, 5593.
Monacelli, Tommaso (2008) Optimal monetary policy with collateralized household debt and borrowing constraints. In Campbell, John Y. (ed.), Asset Prices and Monetary Policy, pp. 103146. Chicago, IL: The University of Chicago Press.
Reis, Catarina (2011) Entrepreneurial labor and capital taxation. Macroeconomic Dynamics 15, 326335.
Schmitt-Grohe, Stephanie and Uribe, Martin (2004) Optimal fiscal and monetary policy under sticky prices. Journal of Economic Theory 114, 198230.
Svensson, Lars E. O. (1985) Money and asset prices in a cash-in-advance economy. Journal of Political Economy 93, 919944.
Recommend this journal

Email your librarian or administrator to recommend adding this journal to your organisation's collection.

Macroeconomic Dynamics
  • ISSN: 1365-1005
  • EISSN: 1469-8056
  • URL: /core/journals/macroeconomic-dynamics
Please enter your name
Please enter a valid email address
Who would you like to send this to? *
×

Keywords

Metrics

Full text views

Total number of HTML views: 0
Total number of PDF views: 20 *
Loading metrics...

Abstract views

Total abstract views: 173 *
Loading metrics...

* Views captured on Cambridge Core between 25th January 2018 - 19th July 2018. This data will be updated every 24 hours.