Indeterminacy, labor and capital income taxes, and non-linear tax schedules

Abstract

Using a finance-constrained model, as in Barinci and Cheron (2001), this paper examines the role of procyclical and countercyclical tax rates on labor and capital income in aggregate fluctuations driven by the beliefs of agents. The analysis shows that the cyclicality of labor income tax rate has the monotonically negative impact on the possibility of indeterminacy, while the non-monotonic relations exist between the cyclicality of capital income tax rate and the likelihood of indeterminacy. It is shown that labor and capital income taxes have remarkably different impacts on the probability of indeterminacy for a sufficiently wide range of variability.