Fiscal Policy. Chris Edmond NYU Stern. Spring 2007

Transcription

1 Fiscal Policy Chris Edmond NYU Stern Spring

2 Agenda Fiscal policy indicators revenue: taxes, issuing debt expenditure: purchases, transfers and interest payments Fiscal policy principles government s intertemporal budget constraint deficits and debt sustainability principles of taxation, debt management 2

3 Fiscal policy concepts Fiscal policy government decisions to spend, raise revenue, and issue debt Expenditure purchases of goods and services (consumption + investment) (schools, police, courts, military, roads) transfers to households and firms (social security outlays, health care) interest payments to holders of government debt Revenue personal and corporate income taxes, tariffs, etc social security contributions 3

4 Period-by-period Government budget constraint expenditure = income In particular G t + V t + rb t = T t + (B t+1 B t ) where G t = government purchases of goods and services V t = transfer payments from government to households T t = tax revenue B t = government debt ( bonds ) 4

5 US government CATEGORY AMOUNT (BILLIONS) Total receipts 3,208.2 Tax receipts 2,169.9 Social insurance Other Total expenditure 3,620.6 Government consumption 1,843.4 Government investment Transfers 1,423.4 Interest payments Balancing item Deficit Source: Bureau of Economic Analysis,

6 Government receipts 0.25 share of GDP 0.20 tax receipts social insurance 0.05 other Source: Bureau of Economic Analysis,

7 Federal receipts Category Billions of dollars Percentage of total Individual income taxes 1, Corporate income taxes Social insurance & retirement Excise taxes Other Total revenue 2, , Source: Statistical Abstract of the United States,

8 Government expenditure 0.35 share of GDP govt consumption 0.15 transfers interest payments 0.00 govt investment Source: Bureau of Economic Analysis,

9 Federal expenditure Component Billions of dollars Percentage of total National defense Health Medicare Income security Social security Net interest Other Total outlays 1, , Source: Statistical Abstract of the United States,

10 Receipts vs. expenditure 0.40 share of GDP expenditure receipts Source: Bureau of Economic Analysis,

11 Government deficit Government deficit equals increase in government debt B t+1 B t = G t + V t T t + rb t Primary deficit equals government deficit less interest payments government deficit = G t + V t T t + rb t primary deficit = G t + V t T t interest payments = rb t 11

12 Government deficit 0.10 share of GDP govt deficit Source: Bureau of Economic Analysis,

13 Interest payments 0.10 share of GDP 0.05 interest payments govt deficit Source: Bureau of Economic Analysis,

14 Primary deficit 0.10 share of GDP 0.05 primary deficit interest payments govt deficit Source: Bureau of Economic Analysis,

15 Federal debt 1.40 share of GDP debt Source: Bureau of Economic Analysis,

16 Cross-country comparisons Which countries are big spenders? big taxers? borrowing a lot? very indebted? Fiscal policy indicators spending, revenue, deficit, debt (all scaled by GDP) 16

17 Fiscal indicators (all as percentage of GDP) Country Spending Revenue Deficit Debt Canada Czech France Germany Japan Korea Sweden UK US ,5 OECD Source: OECD Economic Outlook,

18 What have we learned so far? Fiscal policy decisions to spend, raise revenue, issue debt Deficit government expenditures less revenues change in government debt primary deficit + interest payments 18

19 Fiscal policy principles Intertemporal budget constraint implications of rolling over the period-by-period constraint Deficits and debt sustainability how much government debt is sustainable? Principles of taxation and debt management how do taxes affect incentives to work and save? who/what should be taxed? how high should taxes be? should taxes respond to war? business cycle? demographics? 19

20 Can governments keep running up debt? Government budget constraint G t + V t + rb t = T t + (B t+1 B t ) Government borrowing today implies interest cost tomorrow To get complete complete picture, rollover these period-by-period budget constraints Result is the government s intertemporal budget constraint 20

21 Digression on present values If interest rate is r > 0, present value of a dollar in t periods ( 1 ) t 1 + r Present value of a flow that pays X t at t is t=0 ( ) t 1 X t 1 + r Simple example: if X t = X all t, then t=0 ( ) t 1 X = 1 + r X 1 + r r 21

22 Define primary government surplus X t T t G t V t Debt dynamics Then government budget constraint is B t+1 B t = rb t X t 22

23 Define primary government surplus X t T t G t V t Debt dynamics Then government budget constraint is B t+1 B t = rb t X t Rearrange to get B t = r (B t+1 + X t ) 23

24 Define primary government surplus X t T t G t V t Debt dynamics Then government budget constraint is B t+1 B t = rb t X t Rearrange to get B t = r (B t+1 + X t ) And next period B t+1 = r (B t+2 + X t+1 ) 24

25 Iterating forward This period B t = r (B t+1 + X t ) And next period B t+1 = r (B t+2 + X t+1 ) 25

26 Iterating forward This period B t = r (B t+1 + X t ) And next period, etc, B t+1 = r (B t+2 + X t+1 ) Iterate forward B t = r ( ) r (B t+2 + X t+1 ) + X t Keep doing this many times 26

27 Intertemporal budget constraint After some S + 1 iterations, we get B t = ( ) S+1 1 B t+s r 1 + r S s=0 ( ) s 1 X t+s 1 + r 27

28 Intertemporal budget constraint After some S + 1 iterations, we get B t = ( ) S+1 1 B t+s r 1 + r S s=0 ( ) s 1 X t+s 1 + r As S, we get... B t = r s=0 ( ) s 1 X t+s 1 + r 28

29 Intertemporal budget constraint B t = r s=0 ( ) s 1 X t+s 1 + r Discussion Implications debt is present value of future primary surpluses debt is current promise to make future payments current deficit must be offset by future surpluses so a deficit-financed tax cut now means...? 29

30 Intertemporal budget constraint B t = r s=0 ( ) s 1 X t+s 1 + r Problems Implications: can we always rollover period-by-period budgets? what if government promise to repay is not credible? other problems? 30

31 Debt sustainability Simple model government budget constraint B t+1 B t = rb t + G t + V t T t real output grows at rate g Y t+1 = (1 + g)y t primary deficit/surplus is given exogenously b t B t Y t x t G t + V t T t Y t 31

32 Debt sustainability Debt/output dynamics b t+1 b t = r g 1 + g b t g x t (see notes for details) Simple example, x t = x all t b t+1 b t = r g 1 + g b t g x Steady state debt/output ratio b = 1 r g x ( sustainable ) 32

33 Example Steady-state debt/output ratio b = 1 r g x Example: US debt/output ratio is If g = 0.02 and r = 0.05, what surplus is needed to sustain this indefinitely? Answer: x = (r g)b = ( )0.60 = A primary surplus of 1.8% of GDP. Question: what if g > r? 33

34 Taxation Tax instruments labor income taxes capital income taxes consumption taxes, sales taxes, value-added taxes others? 34

35 Incentive effects Most taxes affect incentives taxes on labor income affect decisions to work taxes on capital income affect decisions to save/invest distort allocations of scare resources, inefficient Lump-sum or poll taxes do not affect incentives how much does that matter? efficiency vs. equity? 35

36 London, May 1990 poll tax protests/riots Trafalgar Square 36

37 What causes the least inefficiency? Principles of taxation tax things with relatively inelastic demand or supply (cigarettes, alcohol, etc) use large base to keep tax rates low (minimize deductions, exceptions) Should we tax capital? 37

38 What causes the least inefficiency? Principles of taxation tax things with relatively inelastic demand or supply (cigarettes, alcohol, etc) use large base to keep tax rates low (minimize deductions, exceptions) Should we tax capital? as little as possible: very elastic supply in long run problem: very inelastic supply in short run, so governments are tempted 38

39 Sources of tax revenue, share of total Country Personal Corporate Social sec. Property Sales/VAT Canada Czech France Germany Japan Korea Sweden UK US OECD Source: OECD Economic Outlook,

40 How should wars be financed? raise taxes? issue debt? War finance 40

41 War finance How should wars be financed? raise taxes? issue debt? Should run deficit during war, issue debt tax smoothing repay debt by running surpluses in peacetime Problems? 41

42 Business cycles How should fiscal policy react to business cycle? cut taxes in recession? raise taxes in boom? 42

43 Business cycles How should fiscal policy react to business cycle? cut taxes in recession? raise taxes in boom? Fiscal policy is too clumsy for active management takes time to pass legislation instead rely on automatic stabilizers and monetary policy 43

44 Demographics What are the fiscal implications of demographic changes? How should government respond to aging population? Issues increasing dependency ratio (more retirees per working person) unfunded liabilities (social security, medicare obligations) what are our intergenerational obligations? What are the right policy responses? tax increases? benefit cuts? more debt? immigration? 44

45 Talking points The longer the deficit continues, the larger the tax burden on future taxpayers. Do you agree? 45

46 Talking points The longer the deficit continues, the larger the tax burden on future taxpayers. Do you agree? yes, if you mean T t, not necessarily if you mean T t /Y t if you mean the latter, answer depends on r vs. g 46

47 Talking points Social security a social insurance program (e.g., disability) not a retirement account if so, should we compare returns on social security with returns on other investments? 47

48 Government deficit What have we learned today? change in government debt, primary deficit + interest Intertemporal budget constraint debt is present value of future primary surpluses implications for debt sustainability Principles of taxation tax inelastic goods and services to minimize efficiency losses use large base to keep tax rates low tax smoothing: run deficits in wartime, don t use fiscal policy to actively manage business cycle 48