The Heterogenous Effects of Government Spending: It’s All About Taxes

Venue: EUI, Department of Economics

The paper explores the role which the progressivity of the tax system plays in determining fiscal multipliers, using a framework with heterogeneous households, uninsurable idiosyncratic risk and indivisible labour supply. The results indicate that a higher degree of progressivity in the income tax system results in larger fiscal multipliers. These findings are compared to empirical evidence on the response of output and consumption to changes in military spending in the US, which also suggests that the effect of government spending increases has been more expansionary when tax progressivity is higher.