Tayler, William John and Zilberman, Roy (2017) Taxation, Credit Spreads and Liquidity Traps. Working Paper. Lancaster University, Department of Economics, Lancaster.
TaylerZilberman_2018_Unconventional_Tax_.pdf
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Abstract
We argue that optimal state-contingent variations in asset taxation increase welfare, alter the monetary policy transmission mechanism and insure against liquidity traps. These findings are explained by an endogenous relationship between taxation, the effective rate of return on assets, the inflationary output gap and credit spreads. Such unique link operates via a working-capital cost channel, and affords the policy maker an additional degree of freedom in stabilizing the economy. Optimal policy calls for lowering (increasing) asset taxation following adverse financial (demand) shocks. Severe financial contractions, nonetheless, warrant a more limited tax cut to minimize the occurrence of unintended liquidity traps induced by (otherwise optimal) large fiscal subsidies.