Income taxes, spending composition and long-run growth

The focus of this paper is threefold. First, it reexamines the impact on long-run growth of changes in flat-rate income taxes when a fraction of total government expenditures is used to provide public services that affect the productivity of privately held inputs. Second, for a given tax policy, this paper studies the impact of government expenditure composition on the rate of economic growth. Third, since demographics follow an overlapping generations structure and fiscal policy affects the economy's productivity, the paper features the role of productivity as a means of redistributing income across generations. The economy is analyzed numerically and policy experiments are carried out.     

Exchange market reform,inflation, and fiscal deficits

This paper examines the effects of exchange market reform on inflation and quasifiscal deficits in developing countries. The first part presents the conceptual framework, which identifies a variety of implicit taxes and subsidies that must be taken into account (in addition to implicit taxes on exports, as emphasized by Pinto (1991)) in assessing the fiscal and inflationary effects of exchange market reform. A formula that attempts to capture explicitly these taxes and subsidies is derived. The second part applies the formula to six countries (Guyana, India, Jamaica, Kenya, Sierra Leone, and Sri Lanka). The results suggest that exchange market reform may lead to a significant reduction in reliance on the inflation tax.     

Public debt dynamics with tax revenue constraints

We develop a dynamic model of public debt under the assumption that it is problematic for governments to implement fast increases of tax revenues, as new taxes require costly infrastructure and expertise that can be built only over time. In this environment, the standard condition requiring economic growth greater than interest costs is not sufficient to guarantee financial stability. Debt might become unstable if the gap between these two indicators falls below a given threshold. Our empirical analysis based on historical public finance data for the US provides strong support for the model. This study conveys a cautionary warning, because the debt of relatively safe borrowers may suddenly become unstable for instance because of a substantial deceleration in the growth of nominal income. These issues can be particularly relevant for those countries that do not have a modern and efficient tax collection system.     

Income distribution, borrowing constraints and redistributive policies

This paper sheds light on the relationship between income inequality and redistributive policies and provides possible guidance in the specification of empirical tests of such a relationship. We model a two-period economy where capital markets are imperfect and agents vote over the level of taxation to finance redistributive policies that enhance future productivity. In this context, we show that the pivotal voter is not necessarily the agent (class) with median income. In particular, the poor, who are more likely to be liquidity constrained, may form a coalition with the rich and vote for low redistribution. The effects of an increase in income inequality on the level of redistribution turn out to depend on whether the increase in inequality is concentrated among the poor or the middle class. Empirical results from a panel of 22 OECD countries provide preliminary evidence consistent with our main theoretical implications.     

Public versus private risk sharing

Can public income insurance through progressive income taxation improve the allocation of risk in an economy where private risk sharing is incomplete? The answer depends crucially on the fundamental friction that limits private risk sharing in the first place. If risk sharing is limited because insurance markets are missing for model-exogenous reasons (as in Bewley (1986) [8]) publicly provided risk sharing improves on the allocation of risk. If instead private insurance markets exist but their use is limited by limited enforcement (as in Kehoe and Levine (1993) [23]) then the provision of public insurance interacts with equilibrium private insurance, as, by providing risk sharing, the government affects the value of exclusion from private insurance markets and thus the enforcement mechanism of these contracts. We characterize consumption allocations in an economy with limited enforcement and a continuum of agents facing plausible income risk and tax systems with various degrees of progressivity (public risk sharing). We provide conditions under which more publicly provided insurance actually reduces total insurance for agents (excess crowding-out), or under which more public insurance increases total insurance (partial crowding-out).     

Intergovernmental transfers and procyclical public spending

This paper tests the predictions that (i) sub-central government expenditures are procyclical and (ii) sub-central government expenditures are likely to be more procyclical than central government spending. The predictions are based on the importance of ‘voracity effects’ and on the proposition that they are systematically more pervasive if spending is financed by intergovernmental transfers. Evidence from 23 OECD countries between 1995 and 2006 indicates that sub-central government spending is more procyclical than central government expenditure.     

The composition of government spending and the multiplier at the zero lower bound

We investigate the size of the multiplier at the ZLB in a New Keynesian model. It ranges from around −0.25 to +1.5, depending on the extent to which the government spending is productive, substitutable or not for private consumption.     

Procyclical government spending: Patterns of pressure and prudence in the OECD

This paper tests for differences in the cyclicality of government spending across functional categories. Evidence from 20 OECD countries suggests that procyclicality is more likely in smaller functional budgets, but capital spending is more likely to be procyclical for the larger spending categories.     

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.     

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.     

On indeterminacy and growth under progressive taxation and productive government spending

We examine the theoretical interrelations between equilibrium (in)determinacy and economic growth in a one‐sector representative‐agent model of endogenous growth with progressive taxation of income and productive flow of public spending. We analytically show that, if the demand‐side effect of government purchases is weaker, the economy exhibits an indeterminate balanced‐growth equilibrium and belief‐driven growth fluctuations when the tax schedule is sufficiently progressive or regressive. If the supply‐side effect of public expenditures is weaker, indeterminacy and sunspots arise under progressive income taxation. In sharp contrast to traditional Keynesian‐type stabilization policies, our analysis finds that raising the tax progressivity may destabilize an endogenously growing economy with fluctuations driven by agents’ self‐fulfilling expectations.     

The impact of the 2008 German corporate tax reform: A dynamic CGE analysis

In this paper we develop the dynamic CGE model, ifoMod, which is designed to analyse the impact of fundamental tax reforms and in particular capital income tax reforms for Germany. The model is in line with neoclassical growth theory and features all important behavioural interactions between the four major building blocks of an economy including the firm and household sector, the government and the rest of the world. We consider firms of different legal forms which all face an intertemporal investment problem, a financing problem w.r.t. the optimal choice of debt and equity financing as well as a factor input problem when deciding on the optimal amount of different skill types of labour employed. We show the impact of different types of taxes on the behavioural margins of firms and households. The conducted simulation shows the impact of the latest German corporate tax reform of 2008 on the German macroeconomic variables such as investments, GDP, consumption and household's welfare.     

Public provision of health insurance and aggregate saving in an overlapping generations model with endogenous health risk: The South Korean case

This paper examines the effect of expanding public health insurance in South Korea on medical expenditures and aggregate saving using an overlapping generations model with endogenous health risk. South Korea had a substantial underinsured population, which is aging rapidly. Higher public health insurance benefits reduce individual medical expenditure and health risks but lead to a modest decline in individual and aggregate saving. Even after the expansion, the medical care coverage remains incomplete, and the elderly face a substantial risk of out-of-pocket medical expenditures.     

Government size,composition of public spending and economic growth in Brazil

The performance of the fiscal policy is largely affected by the relationship between government size, composition of public spending and economic growth. We use a theoretical framework to find optimal relations among these variables and confront them with a panel data for the Brazilian states. Private capital and government spending are substitute inputs in production as the Brazilian states require provision of public spending to fill gaps in the underdeveloped private sector. Public investment and current government expenditures are combined in fixed ratios in the overall government spending due to strong rigidity of the public budget. The optimal share of public investment is considerably lower than current expenditures, as occurs in developing countries characterized by low economic dynamism. Finally, the average tax burden from the data is below the estimated optimal level, meaning that there is space for increasing tax rate without harming economic growth for some Brazilian states.     

Boosting confidence: Is there a role for fiscal policy?

This paper investigates the widely held view that expansionary fiscal policy can boost consumer and business confidence, which will stimulate private spending and sustain economic activity. We find evidence in favor of this conjecture, i.e., cuts in direct taxes generate a positive effect on consumer and business confidence, while the same applies in cases of higher non-wage government consumption. However, higher government wage bills and government investment reduce confidence, with the effect being more pronounced when the Debt to GDP ratio is high, possibly because they entail a permanent increase in the size of the public sector, which would have to be financed by higher future taxes.     

MACROECONOMIC AND REDISTRIBUTIONAL EFFECTS OF CONSUMPTION TAXES IN THE USA*

This paper studies the effect of an increase in consumption taxes using a dynamic general equilibrium model of overlapping generations calibrated to the US economy. When the proceeds are used to reduce income taxes, the reform raises the aggregate capital and labour supply in the long run. Workers increase labour supply immediately in response to the reform, while consumption rises only gradually. The tax reform also transfers wealth from old consumers to young consumers. As a result, while future generations experience significant welfare gains, current generations, particularly old consumers, tend to experience sizable welfare losses. When the proceeds are used for a lump‐sum transfer, the aggregate capital and labour both decrease in the long run. This reform is welfare‐improving for the current low‐income households.     

A dynamic‐efficiency rationale for public investment in the health of the young

In this paper we assume away standard distributional and static‐efficiency arguments for public health and instead seek a dynamic efficiency rationale. We study a lifecycle model wherein young agents make health investments to reduce mortality risk. We identify a welfare rationale for public health under dynamic efficiency and exogenous mortality even when private and public investments are perfect substitutes. If health investment reduces mortality risk but individuals do not internalize its effect on the life‐annuity interest rate, the “Philipson‐Becker effect” emerges; when the young are net borrowers, this works together with dynamic efficiency to support a role for public health.     

Public debt and optimal taxes without commitment

Benhabib and Rustichini [Optimal taxes without commitment, J. Econ. Theory 77 (1997) 231-259] study the properties of optimal capital taxes in economies without commitment and no government debt. They find that capital taxes may be different from zero at steady state. This note shows that, once governments have the possibility of issuing debt and smoothing taxes over time, optimal steady state capital taxes turn out to be zero.     

Social polarization, fiscal instability and growth

We present a dynamic model of fiscal policy in a simple growth framework where social polarization (of preferences) plays a central role in the evolution of fiscal instability and growth collapse. In a highly polarized society, a deficit occurs endogenously, fiscal spending path becomes more volatile, output collapses, and economic growth rate is reduced along the transition path to a new lower level of output. One novel feature is that the size of fiscal deficit, the magnitude of fiscal volatility, and the size of reduction in output and growth rate are explicitly shown to be increasing functions of the degree of social polarization. This is because of the positive relationship between the polarization of preferences and the incentive for policymakers (or socio-economic groups) to overexploit the government resources in a common pool setting (polarization effect). Thereby, we offer a fiscal instability channel that negatively links social polarization and growth, which is an alternative yet distinct explanation for the empirical finding that social polarization is harmful to growth. Moreover, we fully distinguish the incentive to engage in such short-term policies under political uncertainty from that under polarization. Polarization and political uncertainty are shown to be distinct yet critical to the dynamic coordination failure in the common pool setting.     

On the risk of long-run deflation

I determine expected long-run inflation in a two-state New Keynesian model driven by natural interest-rate uncertainty. Monetary policy switches between discretion in ‘normal times’ and zero-lower-bound episodes when it is passive. Long-run US inflation ranges from −1.8% to +1.2% p.a.