Dynamic consequences of removing access to lump-sum taxation

General DSGE Modeling
1

I’m working on a model with both lump-sum and distortionary taxation, I’d like to be a little bit more realistic removing the lump-sum taxes, and thus giving an active dynamic effect to distortionary taxes. Nonetheless, I think that it’s not that common to remove lump-sum taxation in works of this kind, unless it treats that specific topic. Also, I have seen a paper that for business cycles shocks analysis allows lump-sum taxation, since the authors argue that not doing so could cause dynamics that are hard to interpret.

It’s worth noting that my work is not specifically about taxation nor fiscal policy, but I added the distortive taxes anyway, also my main focus is business cycle analysis. Then, I’d be very grateful to hear some comments on how could it affect my (monetary) model, and if it’s worth in terms of the model quality to engage in that endeavor.

Thanks!

2

The question is what you are trying to do with your model. If you want to make a theoretical point i.e. investigate a mechanism, then confounding effects via fiscal rules are not something you want to consider. But if you are trying to make an empirical point, then lump-sum taxes are clearly unrealistic.

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