Data Management

Fiscal Policy, Maintenance Allowances And Expectation-Driven Business Cycles

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Executive Summary

Firms devote significant resources to maintain and repair their existing capital. Within a real business cycle model featuring arguably small aggregate increasing returns, this paper assesses the stabilizing effects of fiscal policies with a maintenance expenditure allowance. In this setup, firms are authorized to deduct their maintenance expenditures from revenues in calculating pre-tax profits, as in many prevailing tax codes. While flat-rate taxation does not prove useful to insulate the economy from self-fulfilling beliefs, a progressive tax can render the equilibrium unique. However, the authors show that the required progressivity to protect the economy against sunspot-driven fluctuations is increasing in the maintenance-to-GDP ratio.

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