Aggregate Instability and the Sectoral Composition of Fiscal Policy

The aim of this papier is to investigate how sector-specific tax rates are destabilizing and lead to expectation-driven fluctuations through the presence of local indeterminacy. We explore this issue within a two-sector model where firms produce either a pure consumption good or a pure investment good and pay an output tax which varies with the tax base. We find that hte composition of sectoral taxes matter since expectation-driven fluctuations requires the presence of a tax in the investment good sector whose cyclicality depends on the tax in the consumption good sector and the size of the elasticity of substitution. In particular, local indeterminacy appears either if the tax rate in the investment good sector is countercyclical with a procyclical tax in the consumption good sector, or if the tax in the investment good sector is procyclical with a tax that is countercyclical enough in the consumption good sector. We also show that this destabilizing composition depends on the configuration of factor intensity ranking