Economic Stability and Progressive Taxation in a Growing Economy

The thesis examines the effects of tax progressivity on the stability of a growing economy. This is done based on the AK growth model. My interest in this topic regarding progressive taxation comes from two articles by Shu-Hua Chen and Jang-Ting Guo, published in 2013 and 2016. The articles do not include detailed mathematical proofs contrary to my thesis. The contribution of my paper is therefore the complete mathematical proofs. In this way I show that the conclusions of the papers really are based on mathematical facts, therefore increasing the value of the results. Two different externalities in the production structure are considered. Either the government expenditures are productive, contributing positively to the level of production, or there are productivity spillovers with the level of production depending on the average size of the capital stock as different producers may use different amounts of capital. In the presence of productive government expenditures, the effects of progressivity depend on the degree to which the expenditures impact the demand as well as the supply of the final good. If the government expenditures affect the supply of goods more than the demand, a sharp progressivity of taxation, as well as any degree of regressive taxation, creates instability in the economy. On the other hand, a moderate progressivity creates stability in the economy. However, if the government expenditures affect the demand of goods more than the supply, any degree of progressivity creates instability in the economy and any degree of regressivity creates stability. In the presence of productivity spillovers, any degree of progressive taxation results in an unstable economic development. However, any degree of regressive taxation results in a stable economy. Finally, regardless of type of production externality, a proportional taxation results in a stable economy and a stable growth path