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Income sources, cyclical behaviors of fiscal policy, and welfare conflict

Published online by Cambridge University Press:  12 January 2023

Meng Li  and
Chengrui Xiao
Meng Li
Affiliation:
School of Public Finance and Taxation, Southwestern University of Finance and Economics, Sichuan, China
Chengrui Xiao*
Affiliation:
School of Business, Hohai University, Jiangsu, China
*
*Corresponding author. Email: xiaochengrui2005@126.com. Phone: (86) 25-68514822.
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Abstract

This paper explores the effect of fiscal policy on the welfare of heterogeneous agents with different income sources over the business cycle. Policy experiments allow the government to choose the cyclical properties of fiscal policy instruments conditional on long-run levels to separately maximize the welfare of entrepreneurs and workers. This policy choice creates welfare conflicts between the two groups, which is confirmed by empirical evidence. The government maximizes workers’ welfare by choosing procyclical capital income tax rates and countercyclical labor income tax rates while it optimizes entrepreneurs’ welfare with countercyclical capital income tax rates and strongly countercyclical labor income tax rates. The socially optimal policy is a tradeoff between the welfare of entrepreneurs and workers. The welfare conflict holds when the government modifies the cyclical behavior of policy in a crisis, or it adjusts the long-run level and cyclical behavior at the same time.

Keywords

Welfare conflictheterogeneous agentsfiscal policybusiness cycles
Type
Articles
Information
Macroeconomic Dynamics , Volume 27 , Issue 8 , December 2023 , pp. 2137 - 2164
Copyright
© The Author(s), 2023. Published by Cambridge University Press

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Footnotes

†

We thank Editor William Barnett and the anonymous referee for their constructive comments and advice. We are grateful to Matthias Kredler, Andrés Erosa, Pedro Gomes, Hernán Seoane, and Omar Rachedi for their comments. We also thank the organizers of the student seminars at UC3M.

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