The Laffer Curve in an Incomplete-Market Economy

This paper investigates the characteristics of the Laffer curve in a neoclassical growth model of the US economy with incomplete markets and heterogeneous agents. The shape of the Laffer curve changes depending on which of transfers or government debt are varied to balance the government budget constraint. While the Laffer curve has the traditional shape when transfers vary, it looks like a horizontal S when debt varies. In this case, fiscal revenues can be associated with up to three different levels of taxation. This finding occurs because the tax rates change non-monotonically with public debt when markets are incomplete