Growth, income distribution, and fiscal policy volatility

The relationship between income distribution and economic growth has long been an important economic research subject. Despite substantial evidence on the negative impact on long-term growth of inequality in the literature, however, there is not much consensus on the specific channels through which inequality affects growth. The empirical validity of two most prominent political economy channels - redistributive fiscal spending and taxes, and sociopolitical instability - has recently been challenged. We advance a new political economy channel for the negative link between inequality and growth, a fiscal policy volatility channel, and present strong supporting econometric evidence in a large sample of countries over the period of 1960-2000. Our finding also sheds light on another commonly observed negative relation between macroeconomic volatility and growth. We carefully address the robustness of the results in terms of data, estimation methods, outlier problem, and endogeneity problem that often plague the standard OLS (ordinary least squares) regression.     

Credit and the transmission of fiscal policy shocks: Recent evidence from Greece

Based on the SVAR approach we examine the importance of credit for the transmission of fiscal policy shocks in Greece. Fiscal shocks have more pronounced effects on the output when credit is constrained. Tax burden shocks have the most protracted effects.     

Fiscal decentralization,fiscal rules and fiscal discipline

Fiscal decentralization (FD) and fiscal rules (FR) are institutional mechanisms that are implemented by varying degrees in increasing number of countries. This paper investigates empirically the effect of FR on the effectiveness of FD in achieving fiscal discipline. Panel evidence strongly supports that balanced budget and expenditure rules help FD to achieve this goal, while debt rule has a direct disciplinary effect.     

Spending cuts or tax increases? The composition of fiscal adjustments as a signal

This paper shows that the composition of fiscal adjustments, spending cuts versus tax increases, serves as a signal of the government's degree of collusion with special interests. The politico-economic model of fiscal policies, combining retrospective voting with common-agency-type lobbying, presents undominated separating equilibria and intuitive pooling ones, in both of which fiscal adjustments with sufficiently large spending cuts lead to incumbent reappointment whereas those with only tax increases lead to incumbent defeat. These findings are consistent with the recent empirical evidence of voters behaving as fiscal conservatives. The efficiency-enhancing aspects of the signaling mechanism and the effects of imposing a deficit limit are also analyzed.     

Public budget composition,fiscal (de)centralization,and welfare

Abstract We study the optimal degree of fiscal decentralization in a dynamic federal economy where governments decide on budget size and its allocation between public education and infrastructure spending. We find that full centralization of tax and expenditure policies is optimal when infrastructure productivity is similar across regions. When differences are not too large, partial centralization is optimal. With strong differences, full decentralization becomes optimal. National steady‐state output tends to be highest under full decentralization. We provide a justification for the mixed evidence regarding the Oates conjecture by showing that full dominates partial decentralization, despite being inferior to complete decentralization.     

Time-consistent taxation in a dynastic family model with human and physical capital and a balanced government budget

Abstract .  This paper analyzes optimal, time consistent taxation in a dynastic family model with human and physical capital and with a balanced government budget. When tax revenue is used for publicly provided consumption or lump-sum transfers, leisure would be higher than its social optimum. Pareto optimal taxation requires taxing capital income more heavily than labour income and subsidizing investment at the same rate of the tax. Also, it requires either subsidizing labour at the same rate as a consumption tax or subsidizing consumption at the same rate as a labour income tax, and hence it is not a practical guide to policy. Further, a consumption tax, or equivalently a uniform income tax with investment subsidies at the same rate, can be improved on by taxing capital income more heavily than labour income.     

An estimated fiscal Taylor Rule for the postwar United States

This paper estimates a multi-instrument fiscal Taylor Rule for the United States. Taxes and purchases both respond strongly to deficits, while transfers do not. Taxes are procyclical; purchases are acyclical; and transfers are countercyclical. These estimates appear stable over time.     

A golden rule of public finance or a fixed deficit regime?: Growth and welfare effects of budget rules

In this paper, we compare growth and welfare effects of various budget rules within an endogenous growth model with productive public capital, utility enhancing public consumption and public debt. We find that introducing a fixed deficit regime does not affect the long run growth rate compared to a balanced budget while establishing a golden rule results in higher growth. Simulations of welfare effects indicate that a golden rule leads to highest welfare followed by a balanced budget and a fixed deficit regime. A maximum fraction of deficit financed public investment is derived. Varying the intertemporal elasticity of substitution shows that economies populated by households who have a strong tendency to smooth consumption should adhere to a balanced budget from a welfare point of view.     

Are external shocks responsible for the instability of output in low-income countries?

External shocks, such as commodity price fluctuations, natural disasters, and the role of the international economy, are often blamed for the poor economic performance of low-income countries. This paper quantifies the impact of these different external shocks using a panel vector auto-regression approach and determines their contributions to output volatility in low-income countries. We find that they can only explain a small fraction of the output variance of a typical low-income country. Other factors, most likely internal causes, are the main source of fluctuations. From a quantitative perspective, the output effect of external shocks is typically small in absolute terms, but significant relative to the historic performance of these countries.     

Financial markets’ behavior around episodes of large changes in the fiscal stance

Using a panel of OECD countries from 1960 to 2002, this paper shows that interest rates, particularly those of long-term government bonds, decrease when countries’ fiscal position improves and increase around periods of budget deteriorations. Stock market prices surge around times of substantial fiscal tightening and plunge in periods of very loose fiscal policy. In addition, the paper shows that results depend on countries’ initial fiscal conditions and on the type of fiscal consolidations: Fiscal adjustments that occur in country-years with high levels of government deficit, that are implemented by cutting government spending, and that generate a permanent and substantial decrease in government debt are associated with larger reductions in interest rates and increases in stock market prices.     

Growth effects of government expenditure and taxation in rich countries: A reply

Agell et al. (2005) criticise our earlier findings (Fölster and Henrekson 2001) of a robust negative relationship between government size and economic growth for an extended sample of rich countries. In this short paper it is argued that their critique is unfounded. Most importantly, the critique does not deal with the main result of the original study, namely that the most complete specifications for assessing the relationship between government expenditure and growth in rich countries are robust even according to stringent extreme bounds criteria.     

An instrumental variables approach to estimating tax revenue elasticities: Evidence from Sub-Saharan Africa

This paper exploits the significant response of real GDP growth of Sub-Saharan African countries to exogenous international commodity price and rainfall shocks to construct instrumental variables estimates of the tax revenue elasticity IV estimates yield that a 1% increase in GDP increases tax revenues by up to 2.5%.     

Growth,unemployment and public capital

Abstract. Existing literature has studied the growth effects of fiscal policy in models with full-employment. The aim of this paper is to study these growth effects in an endogenous growth model with unemployment and compare them with the effects obtained when there is full-employment. To this end, we assume that unemployment arises due to the existence of unions. We also assume that the government finances, by means of income taxes, both public capital and an unemployment benefit. Public capital increases total factor productivity and modifies the elasticity of the labor demand. We show that the effects of fiscal policy on both employment and growth crucially depend on the relation between this elasticity and public capital. We would like to thank Jordi Caballé, Fernando Sánchez, Manuel Santos and an anonymous referee for their helpful comments. Sorolla is grateful for financial support to Spanish Ministry of Education through DGICYT grant SEC2000-0684 and to Generalitat de Catalunya through grant SGR2001-164. Raurich is grateful to Universitat de Girona for financial support through grant 9100075.     

Fiscal policy over the real business cycle: A positive theory

This paper explores the implications of the political economy model of Battaglini and Coate (2008) [8] for the behavior of fiscal policy over the business cycle. The model predicts that fiscal policy is counter-cyclical with debt increasing in recessions and decreasing in booms. Public spending increases in booms and decreases during recessions, while tax rates decrease during booms and increase in recessions. In both booms and recessions, fiscal policies are set so that the marginal cost of public funds obeys a submartingale. When calibrated to the US economy, the model broadly matches the empirical distribution of debt and also its negative correlation with output. However, the predictions of pro-cyclical spending and counter-cyclical taxation do not find empirical support. The calibrated model generates the same fit of the data as a benevolent government model in which the government faces an exogenous lower bound on debt. Nonetheless, the two models have very different comparative static implications.     

What is the optimal rate of R&D investment to maximize productivity growth?

Governments in modern economies devote much policy attention to enhancing productivity and continue to emphasize its drivers such as investment in R&D. This paper analyzes the relationship between productivity growth and levels of R&D investments. The econometric analysis shows that more than 65 per cent of productivity growth variance is due to its dependence on gross domestic expenditure on R&D expressed as percentage of GDP (GERD). Economic analysis shows that productivity growth = f(GERD) is a concave function downwards due to diminishing returns to research investments. In addition, the research shows that the range of GERD between 2.3 per cent and 2.6 per cent maximizes the long-run impact on productivity growth and it is the key to sustained productivity and technology improvements that are becoming more and more necessary to modern economic growth.     

Public debt in a basic endogenous growth model

We work out the mechanism that makes public debt affect the allocation of resources in the long-run. To do so we analyze an AK growth model with elastic labor supply and a government sector. The government levies a distortionary income tax and issues bonds to finance lump-sum transfers and non-distortionary public spending. We show that the long-run growth rate is the smaller the higher the debt ratio if the government adjusts public spending to fulfill its inter-temporal budget constraint. If the government adjusts lump-sum transfers the public debt ratio does not affect the balanced growth rate.     

On the size of fiscal multipliers: A counterfactual analysis

We point out that fiscal multipliers derived from SVAR-models include the predicted future path of policy instruments. After the initial shock, net taxes and government expenditures react to each other and are autocorrelated. In a counterfactual simulation, we report fiscal multipliers that abstract from these dynamic responses.     

Social security, retirement age and optimal income taxation

It is often argued that implicit taxation on continued activity of elderly workers is responsible for the widely observed trend towards early retirement. In a world of laissez-faire or of first-best efficiency, there would be no such implicit taxation. The point of this paper is that, when first-best redistributive instruments are not available, because some variables are not observable, the optimal policy does imply a distortion of the retirement decision. Consequently, the inducement of early retirement may be part of the optimal tax-transfer policy. We consider a model in which individuals differ in their productivity and their capacity to work long and choose both their weekly labor supply and their age of retirement. We characterize the optimal non-linear tax-transfer that maximizes a utilitarian welfare function when weekly earnings and the length of active life are observable while individuals' productivity and health status are not observable.