First - Best Fiscal Policy with Social Status ∗

This paper examines the first-best fiscal policy in a stochastic, infinite-horizon representative agent model that exhibits consumption-enhanced as well as wealth-enhanced social status in the household utility. We show that the first-best labor tax rate is a positive constant that is used to correct negative consumption externalities. The first-best capital tax rate is also positive in order to overturn agents’status-seeking capital over-accumulation. Moreover, we find that in contrast to a conventional automatic stabilizer, the first-best capital tax moves in the opposite direction with shocks to firms’production technology. This result turns out to be qualitatively consistent with the discernible empirical evidence that many countries have implemented procyclical fiscal policies.