DP5796 Tax Rate Variability and Public Spending as Sources of Inderterminacy

Author(s): Teresa Lloyd-Braga, Leonor Modesto, Thomas Seegmuller
Publication Date: August 2006
Keyword(s): indeterminacy, public spending, segmented asset markets, taxation
JEL(s): E32, E63, H23
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5796

We consider a constant returns to scale, one sector economy with segmented asset markets, encompassing both the Woodford (1986) and overlapping generations models. We analyze the role of public spending, financed by (labour or capital) income and consumption taxation, on the emergence of indeterminacy. We find that what is relevant for indeterminacy is the variability of the distortion introduced by government intervention. We further discuss the results in terms of the level of the tax rate, its variability with respect to the tax base and the degree of externalities in preferences due to the existence of a public good. We show that the degree of public spending externalities affects the combinations between the tax rate and its variability under which indeterminacy occurs. Moreover, in contrast to previous results, we find that consumption taxes can lead to local indeterminacy when asset markets are segmented.