SSE/EFI Working Paper Series in Economics and Finance,
Stockholm School of Economics

Abstract: This paper examines the role for tax policies in productivity-shock driven economies with "catching-up-with -the-Joneses" utility functions. The optimal tax policy is shown to affect the economy counter-cyclically via procyclical taxes, i.e., "cooling down" the economy with higher taxes when it is "overheating" in booms and "stimulating" the economy with lower taxes in recessions to keep consumption up. Thus, models with catching-up-with-the-Joneses utility functions call for traditional Keynesian demand management policies. Parameter values from Campbell and Cochrane (1995) are also used to illustrate that the necessary labor taxes can be very high, in the order of 50 percent. However, Campbell and Cochrane's nonlinear version of the benchmark level in the catching-up-with-the-Joneses preferences has the implication that consumption bunching can be welfare enhancing.

Keywords: Catching-up-with-the-Joneses preferences; fiscal policy; taxation

JEL-codes: E21; E62; E63

29 pages, September 28, 1998

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Lars Ljungqvist and Harald Uhlig, 'Tax Policy and Aggregate Demand Management under Catching up with the Joneses', American Economic Review

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