Built-in flexibility of taxation and stability when tax liabilities respond with a time lag

Abstract

Given tax rates, tax revenues rise as income rises. This property of a tax system is known as 'built-in flexibility of taxation' and it is widely regarded as a stabilising force. The present paper analyses a model in which tax liabilities are a lagged function of income and consumption adjusts to disposable income either with or without time lags. It is shown that in such a system built-in flexibility of taxation is de-stabilising rather than stabilising, that short (two period) oscillations may be induced and that the magnitude of an economy's fluctuations may be increased.