On indeterminacy and growth under progressive taxation and productive government spending

We examine the theoretical interrelations between equilibrium (in)determinacy and economic growth in a one-sector representative-agent model of endogenous growth with progressive taxation of income and productive flow of public spending. We analytically show that, if the demand-side effect of government purchases is weaker, the economy exhibits an indeterminate balanced-growth equilibrium and belief-driven growth fluctuations when the tax schedule is sufficiently progressive or regressive. If the supply-side effect of public expenditures is weaker, indeterminacy and sunspots arise under progressive income taxation. In sharp contrast to traditional Keynesian-type stabilization policies, our analysis finds that raising the tax progressivity may destabilize an endogenously growing economy with fluctuations driven by agents' self-fulfilling expectations.