Topic12-Fiscal Policy_AAPBW6_Rev

Indefinitely lived entities have to show evidence to

Info iconThis preview shows page 1. Sign up to view the full content.

View Full Document Right Arrow Icon
This is the end of the preview. Sign up to access the rest of the document.

Unformatted text preview: definitely-lived entities have to “show” evidence to the markets that they can pay back their debt Increases the distortionary wedge between wages paid and wages received Distortions increase non-linearly with taxes nonWage elasticity of labor supply is substantial Lump-sum taxes are infeasible Lump- Corporations by being solvent Governments through their taxing capacity orderly and lawful society sustainable borrowing • When these criteria are not met, there is a crisis 75 75 The “Laffer” Curve! Laffer” 78 Do We Have to Pay Back the Debt or Not? • What is “sustainable borrowing” for a government? • That debt doesn’t “grow too fast” relative to the economy Gov Revenue Basically it means that Debt/GDP cannot be expected to rise indefinitely Short-term rises are OK, as long as the market expects them to stop Tax Rate Stopping Debt/GDP ↑ doesn’t mean running surpluses (paying back the debt) It means growing the deficits at less than GDP growth 76 Do We Have to Pay Back the Debt or Not? • In the 2-period model, government definitely has to pay back the debt • In the real world, mortal entities (consumers) also definitely have to pay back their debt Exceptions are bankruptcies • Entities with indefinite lives have different rules Corporations, governments 77 79 Fiscal Stimulus • Passive countercyclical fiscal policy Gov revenues automatically fall in a recession Rise in a recovery That means deficits rise in a recession What to do? NOTHING! NOTHING In the past, governments worried about the rising deficits and proceeded to raise taxes In a recession! Nixon 1972, Roosevelt in 1936, Japan in the 1990s 82 Fiscal Stimulus Example #4 Problem #5 at chapter end –Taxes Distort • Active countercyclical fiscal policy Temporary tax cuts in recessions and/or tax and/or increases in government spending government • Workers value their leisure at 90 units of goods. The production function is Y = 250L – 0.5L2. MPL = 250 - L MPL 1. No taxes: What are the equilibrium wage, L, & Y ? wage to stimulate consumption spending See: “market failure or optimal response?” response?” Also Tax cut may be saved (Ricardian view) no in C (Ricardian Particularly if it a temporary tax cut temporary Huge lags between need for policy and enactment enactment of policy and effect on the economy Even for “shovel-ready” projects as we are finding out shovel- ready” 83 83 91 91 Fiscal Stimulus (concl.) concl.) Example #4 • Increase government expenditures on goods and services, G, to spend on infrastructure, create jobs, etc. Increase in G on a permanent basis reduces goods and services available to the private sector Problem #5 at chapter end –Taxes Distort Problem • Workers value their leisure at 90 units of goods. The production function is Y = 250L – 0.5L2. MPL = 250 - L MPL 1. No taxes: What are the equilibrium wage, L, & Y ? wage In equilibrium, workers will give up 1 unit (hour, day) of leisure for 90 units of goods. This, then will be the wage rate! Therefore, w= There is a tradeoff (public vs. private goods) Since Keynesians believe deficits are bad, they would increase taxes to make up for G Problems: Y= Distortionary income taxes decrease labor supply! Distortionary taxes decrease capital formation 84 92 “Good” Fiscal Policy Good” Example #4 • Choose an “optimal” level of G and TR optimal” TR Problem #5 at chapter end –Taxes Distort Problem Cost-benefit, political equilibrium Cost- • Workers value their leisure at 90 units of goods. The production function is Y = 250L – 0.5L2. MPL = 250 - L MPL 2. Wage tax 25%: What are the equilibrium wage, L, & 25%: wage Y ? What is the distortion cost of the tax in terms of output? w= • Steady tax rates Lowest marginal rates possible Avoid double taxation Profit taxes? Finance deficit fluctuations • In a growing economy, keep Debt/GDP Debt constant on average This implied a steady-state deficit steady- Y= ~$14T GDP, $10T debt ~71% ratio GDP 5.0% $growth implies $ ~500B steady-state deficit! steady85 94 Glossary G Government expenditure S C National Saving = Spvt (private saving) + Sgov (govt. saving) Consumption of households T T r Y PV(X) Perm.Inc. Perm.Inc. Taxes (T1, T2, in two-period setup) twoChange in taxes Real interest rate Real income (GDP) Present Value of X Permanent Income (G1, G2, in a 2-period setup) 2- (C1, C2, in 2-period setup) 2- 96 96 THE END 97...
View Full Document

Ask a homework question - tutors are online