implies that economies under alternative tax structures combine distortionary taxation with lump-sum taxation (or transfers) to ensure a constant level of tax proceeds. The unconditional mean of government spending is also held constant. Notice that the ensuing discussion focuses exclusively on stabilization issues while disregarding efficiency and distribution implications, to use Musgrave’s (1959) famous division of the state into its three functional branches.

Figures 7 and 8 depict relative output volatilities when a given parameter of the tax code is changed, while keeping the other tax parameters constant at their baseline calibration values and when the business cycle is driven by alternative forcing processes. In the economy depicted by Figure 7, households are fully optimizing while the economy of Figure 8 is inhabited by both Ricardian and non-Ricardian households. In the BarroRamsey economy, income taxes are strongly destabilizing in the sense that tax rate increases rapidly translate into higher output volatilities across most sources of business fluctuations. However, when the business cycle is driven by technology shocks to the nontradable sector and to a lesser extent by technology shocks to the exportable sector, the positive relationship lessens considerably - to the point where the destabilizing effect practically disappears. In other words, tax rates are more destabilizing when the business cycle is driven primarily by fluctuations such as terms of trade shocks, lending spread shocks, world business cycle shocks and government spending shocks and much less so when driven by technology shocks. The same applies to the parameter determining the slope of the personal tax schedule, e.g., the degree of progressivity of the personal income tax is more destabilizing when the business cycle is driven primarily by terms of trade shocks, lending spread shocks, world business cycle shocks and government spending shocks and much less so when driven by technology shocks.

Other features of the tax code to consider are the personal exemption level and the level exemption in the consumption tax base. Both features are unrelated to the business cycle, e.g., they neither smooth nor destabilize the business cycle. Regarding the deduction of new investment expenses, simulation results show that relative output volatilities are a decreasing function of the fraction of investment in physical capital that can be deducted from corporate income. This is the only feature of the tax code that, in an economy inhabited by fully optimizing households and hit by multiple shocks, operates like an automatic stabilizer.

The introduction of non-optimizing households (Figure 8) flattens the relative volatility schedules quite dramatically (note the difference in the scale of the y-axes in Figures 7 and 8). Under most alternative sources of business fluctuations, relative volatilities do not respond or respond only slightly to changes in tax code parameters. There is one salient exception to this. The consumption tax, the personal income tax rate and the degree of progressivity of the income tax tend to increase the volatility of the economy when the business cycle is driven mainly by terms of trade shocks. Otherwise, results seem to suggest an invariance property: the amplitude of the business cycle is independent of the tax structure. The obvious consequence is that business cycle swings are not dampened by the automatic revenue stabilizers. A cursory look at the LAC data reveals that a case can be made for this. Figure 9 relates the two measures of the size of the automatic revenue stabilizers (see section 2: the sensitivity of the budget balance to the cycle, SBB, 25