Does Nonlinear Taxation Stabilize Small Open Economies?

Abstract

This paper examines the stabilization effect of income taxation rules in small open economies. We show that if endogenous growth is not allowed, belief-driven uctuation will not emerge, but the economy displays total instability under certain conditions and nonlinear income tax may recover saddle point stability. If endogenous growth is possible and if the taxation rule speci es the rate of income tax held in the balanced growth equilibrium, then equilibrium indeterminacy will not arise either. However, if the long run tax rate is not predetermined, then, equilibrium path of the economy may be indeterminate, and an appropriate taxation rule can establish determinacy.