Policy Simulation of Government Expenditure and Taxation Based on the DSGE Model

This study constructs a dynamic stochastic general equilibrium (DSGE) model including four types of government expenditure (merit goods, public goods, government investment, and lump-sum income transfers) and three types of tax (consumption tax, labor income tax, and capital income tax), and estimate the model parameters. We then perform a simulation analysis based on the estimation results. The estimates, using Japanese data from the first quarter of 1981 to the fourth quarter of 2012, suggest that Japanese government expenditure and effective tax rates do not significantly respond to changes in the output gap and cumulative debt. Furthermore, from a simulation analysis based on the estimation results, we draw two main findings. First, as to the differences in taxes used for financing government expenditure, while consumption tax and labor income tax are almost indifferent, capital income tax aggravates the economy in the long term. Second, when using the increased tax revenue derived from raising the consumption tax rate for additional government expenditure, expenditure on merit goods and government investment have positive effects on the economy in the short and long term, respectively.