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The Perils of Tax Smoothing: Sustainable Fiscal Policy with Random Shocks to Permanent Output

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Abstract

If permanent output is uncertain, tax smoothing can be perilous: both debt levels and tax rates are difficult to stabilize and may drift upwards. One practical remedy would be to target the debt. However, our simulations confirm that such a policy would require undesirably volatile fiscal adjustments and may inhibit countercyclical borrowing. An alternative would be to link the primary surplus not only to the debt ratio (like tax smoothing) but also to its volatility, thus preempting further adjustments while gradually reducing the debt.

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Bibliographic Info

Article provided by Charles University Prague, Faculty of Social Sciences in its journal Finance a uver - Czech Journal of Economics and Finance.

Volume (Year): 58 (2008)
Issue (Month): 11-12 (December)
Pages: 502-524

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Handle: RePEc:fau:fauart:v:58:y:2008:i:11-12:p:502-524

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Keywords: tax smoothing; sustainability; forecast error;

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References

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Cited by:
  1. Carlos Garcia & Jorge Restrepo & Evan Tanner, 2007. "Designing fiscal rules for commodity exporters," ILADES-Georgetown University Working Papers inv199, Ilades-Georgetown University, Universidad Alberto Hurtado/School of Economics and Bussines.
  2. Hostland, Doug & Karam, Philippe, 2006. "Assessing debt sustainability in emerging market economies using stochastic simulation methods," Policy Research Working Paper Series 3821, The World Bank.
  3. Jorge Restrepo & Carlos Garcia & Evan Tanner, 2011. "Fiscal Rules in a Volatile World: A Welfare-Based Approach," IMF Working Papers 11/56, International Monetary Fund.
  4. Strawczynski, Michel & Zeira, Joseph, 2009. "Cyclicality of Fiscal Policy: Permanent and Transitory Shocks," CEPR Discussion Papers 7271, C.E.P.R. Discussion Papers.
  5. Evan Tanner, 2013. "Fiscal Sustainability: A 21st Century Guide for the Perplexed," IMF Working Papers 13/89, International Monetary Fund.

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