Tax Policy Under Keeping Up with the Joneses and Imperfectly Competitive Product Markets ∗ Jang-Ting Guo University of California, Riverside † January 13, 2003 Abstract This paper examines the optimal (first-best) fiscal policy in a stochastic representative agent model that exhibits a “keeping up with the Joneses” utility function and imperfectly competitive product markets. We find that the optimal labor tax is a constant, whose sign is determined by the relative strength of consumption externality and monopoly power. Moreover, the optimal capital tax is unambiguously negative and affects the economy countercyclically. Our analysis shows that models with capital accumulation, imperfect competition, and “keeping up with the Joneses” preferences call for traditional Keynesian demand-management policies that are designed to mitigate business cycle fluctuations. Keywords: Fiscal Policy, Keeping Up with the Joneses, Imperfect Competition. JEL Classification: E21, E63, H21. ∗ I thank Daniel Henderson, Sharon Harrison, Kevin Lansing, Robert Russell and seminar participants at Academia Sinica, Taipei, Taiwan and UC Riverside for helpful discussions and comments. All remaining errors are my own. † Department of Economics, University of California at Riversie, Riverside, CA, 92521-0427, Phone: (909) 827-1588, Fax: (909) 787-5685, E-mail: guojt@mail.ucr.edu.