Substitution and Income Effects at the Aggregate Level: the Effective Budget Constraint of the Government and the Flypaper Effect

This paper analyzes the effect of a change in lump-sum (private) income on the tax and expenditure decisions of a government constrained by taxpayers’ behavioral responses to the tax policy. Lump-sum changes of private income are generally characterized as pure income effects on taxpayers’ behavior, and usually considered in public finance theory as… CONTINUE READING