Topic12-Fiscal Policy_AAPBW6_Rev

For instance during a war instead of raising taxes on

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Unformatted text preview: e her taxes by (1 + r) T to finance repayments (1 nd period after tax income to be She expects her 2 (1 + r) T T 1 r 0 The PV of this = 0! T 1 r • The net effect is to leave the present value of her income, and therefore her consumption plan, unchanged unchanged • Implication: A balanced budget every year is not necessarily good. For instance, during a war instead of raising taxes on an already overburdened public, it might be welfare improving to run a deficit; it does not SNat’l Nat’ this is because taxes have distortionary costs distortions increase exponentially with taxes 58 62 Government Cuts Taxes by $1 by $1 and Borrows $1 Ricardian View (cnt.) cnt.) • The key is: Consumers care about the Present Value of their Present tax obligations SNatl Spriv Sgov by < $1 by < $1 by $1 by $1 by $1 Straight from the Permanent Income idea Government’s reducing taxes now and having to Government’ increase them later doesn’t change the PV of taxes doesn’ PV It is a shell game Therefore, the consumer is neither better or worse off Doesn’t change her consumption plan! Doesn’ The tax cut becomes additional saving Traditional View View Ricardian Unchanged View It’ll be used to pay the future higher taxes It’ 59 63 63 Example #3 (Ricardian View) (Ricardian Example #3 (Ricardian View) (Ricardian • Government reduces current taxes by 200 without changing expenditures. What happens to Current Current Consumption, Priv. Saving, Nat’l Savings? Priv. Nat’ • Suppose private consumption is given by 1 PV Net Inc 2 Y1 = 1,600, Y2 = 1,100, T1 = 400, G1 = 600, G2 = 660, 600, r = 10% Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660, 600, G1 = 600, G2 = 660 (balanced budget each period), r = 10% 600, 660 C SPriv SNatl = = = 64 64 69 Example #3 (Ricardian View) (Ricardian Empirical Evidence for the U.S. • Suppose private consumption is given by 1 PV Net Inc 2 Federal Deficits & the Real Rate 10.0% FED DEFICIT 10Y Real Rate CAB/GDP 8.0% Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660, 600, G1 = 600, G2 = 660 (balanced budget each period), r = 10% 600, 660 6.0% 4.0% 2.0% What is Perm. Inc., and the PVs of G, T? Perm. G, Perm Inc = PV(G) = PV PV(T) = -0 6 -0 8 -4.0% -6.0% -8.0% -10.0% 65 73 The “Burden” of Debt in a Nutshell Burden” Example #3 (Ricardian View) (Ricardian C ar ar M M ar -0 2 -0 4 -0 0 -9 8 ar ar M -9 6 ar M M -9 4 -9 2 ar ar ar M M M -8 8 -9 0 ar M -8 6 -8 4 ar ar M M -8 2 ar M -8 0 -7 8 ar ar M M -7 6 ar M -7 4 ar -7 2 ar ar M ar M M -7 0 0.0% -2.0% M C M C 1 PV Net Inc 2 • Gov takes resources from the economy now now but borrows to pay for them! Y1 = 1,600, Y2 = 1,100, T1 = 600, T2 = 660, 600, G1 = 600, G2 = 660, r = 10% 600, 660, What is Current Consumption, Priv. Saving, Current Priv. Nat’l Savings? Nat’ C = SPriv = SNatl = 67 If this tricks consumers into thinking their tricks income is high, they will save less and k will grow more slowly equilibrium k will be lower The issue is the empirical relevance of Ricardian empirical equivalence 74 The “Burden” of Debt (Concl.) Concl.) Burden” Do We Have to Pay Back the Debt or Not? Even if the world is Ricardian • Higher future taxes mean higher future tax distortions • In...
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