The impact of labour tax progressivity on the fiscal multipliers in the contex of fiscal consolidation programs

Abstract

Fiscal multipliers depend on several structural characteristics of each economy. In this work projectit is argued that labor income tax progressivity lowers fiscal multipliers of fiscal consolidation programs. By calibrating a model withincomplete-markets andoverlapping generationsfor the United States,for different values ofthe labor incometax progressivity,it is shown that as progressivity increases,the recessionary impacts of fiscal consolidation are lower in the case of consolidation through decrease of government spending and are more recessionary in the case of consolidation financed with tax hikes. The first case is explained through the positive relationship between labortax progressivity and the percentage of borrowing constrained agents in the economy. In the second case the results are linked to the distortionary effects in the economy of increasing tax progressivity.