Effects of Tax Policy in a Life-Cycle Model with Asset Illiquidity

This study proposes a general equilibrium life-cycle model where households make labor supply decisions and smooth consumption using one asset. This asset involves a stochastic adjustment cost. A recession arises when the tax revenue generated from a tax hike is spent as government expenditures. A prolonged expansion occurs when the revenue is distributed as transfers, especially to older and lower income households with higher savings. The tax hike invariably leads to recession when the adjustment cost is absent. Thus, how tax revenue is spent can significantly affect the aggregate economy once asset illiquidity is considered