Abstract
This paper examines the …rst-best …scal policy in a stochastic, in…nite-horizon representative agent model that exhibits consumption-enhanced as well as wealth-enhanced social status in the household utility. We show that the …rst-best labor tax rate is a positive constant that is used to correct negative consumption externalities. The …rst-best tax rate on capital income is also positive in order to overturn agents’status-seeking capital over-accumulation. Moreover, we …nd that in sharp contrast to a conventional automatic stabilizer, the …rst-best capital tax rate moves in the opposite direction with shocks to …rms’production technology, thus exacerbating the business cycle.
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