Balanced-Budget Rules and Aggregate Instability : The Role of Consumption Taxes in a Monetary Economy

This paper examines the stabilizing property of consumption taxation in a balanced-budget setting of a neoclassical one-sector cash-in-advance economy. We find that saddle-path stability is not a necessary outcome even though the utility function is additively separable between consumption and leisure. Both the existence of a Laffer curve and the indeterminacy outcome of consumption taxation depend on the elasticities of inter-temporal substitution in consumption and of labor supply. Numerical examples show that consumption tax may lead to aggregate instability for the OECD countries under the current over-easy monetary policies