Abstract
Fiscal multipliers depend on several structural characteristics of each economy. In this study it is argued that labor income tax progressivity lowers the fiscal multipliers of fiscal consolidation programs. By calibrating an incomplete‑ markets, overlapping generations model for the United States for different values of the labor income tax progressivity, it is shown that as progressivity increases the recessionary impacts of fiscal consolidation are lower in the case of consolidation through decrease of government spending and are more recessionary in the case of consolidation financed with tax hikes.
Highlights
The aftermath of the 2008 financial crisis featured the emergence of fiscal consolidation programs across countries, in which the reduction or stabilization of government deficits and public debt derived from increased taxation or decreased government spending, or a combination of the two (Alesina et al, 2019).The vast literature on the subject confirms the relevance of correctly assessing the impact of those programs on the economy, especially on output, represented by the fiscal multipliers
By calibrating an incomplete‐markets, overlapping generations model for the United States for different values of the labor income tax progressivity, it is shown that as progressivity increases the recessionary impacts of fiscal consolidation are lower in the case of consolidation through decrease of government spending and are more recessionary in the case of consolidation financed with tax hikes
If for the decrease of government spending a lower multiplier means that as progressivity increases the recessionary impact of fiscal consolidation programs is smaller, for the increase of taxes, a lower multiplier means that as progressivity increases the recessionary impact of fiscal consolidation are larger
Summary
The aftermath of the 2008 financial crisis featured the emergence of fiscal consolidation programs across countries, in which the reduction or stabilization of government deficits and public debt derived from increased taxation or decreased government spending, or a combination of the two (Alesina et al, 2019). This study contributes to the already existent research by raising the question of whether the multiplicity of fiscal multipliers across time and countries may be in part a reflection of differences in labor income tax progressivity It studies the potential relationship between heterogeneity in labor income tax progressivity and the impact of fiscal policies on output, in the particular context of fiscal consolidation programs. The relation between progressivity and fiscal multipliers, in the case of increase government spending financed by an increase in lump‐sum taxation, is documented in Brinca et al (2016) It works again as a result of the limitations of borrowing constrained agents to face a change in income.
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