Progressive Taxation of Labor Income, Taylor Principle and Monetary Policy

Progressive labor income taxation in an otherwise standard NK model: (i) introduces a trade-o¤ between output and in‡ation stabilization; (ii) enlarges the determinacy region in the parameter space, substantially altering the so-called Taylor principle; (iii) has non-linear dynamic e¤ects and changes the responses of the economy to a technology and to a government spending shock; (iv) sensibly alters the prescription for the optimal discretionary interest rate rule; (v) the welfare gains from commitment are a decreasing function of the degree of the progressiveness of the labor income tax. The key point is that, whatever the set up, the literature on monetary policy cannot disregard the progressive taxation on labor income which characterized the most of OECD countries. JEL CODES: E50, E52, E58