Wednesday, March 12, 2014 | 2:00pm -3:30pm | Room 231, HSBC Business School Building

Abstract

This paper quantitatively examines the long-run effects of resource misallocation on the economy’s aggregate variables within an otherwise standard one-sector neoclassical growth model in which output production is carried out by heterogeneous firms subject to progressive taxation as well as entry and exit regulations. Under a progressive fiscal policy rule, capital and labor inputs move from more productive firms to less productive establishments which face a relatively lower tax rate. Since low-productivity firms use an inefficiently high level of productive resources, we find that the overall production and aggregate productivity will fall as the tax progressivity rises. By contrast, more progressive taxation may raise the aggregate productivity when the household’s hours worked are postulated to be fixed. Our analysis therefore shows that the quantitative implications of progressive taxation are sensitive to endogenous labor supply and the entry regulations.