The macroeconomic effects of different ways of rolling back the welfare state are analysed. Cutting public spending on market goods induces a lower interest rate, a higher wage, a lower capital stock and a fall in employment. Cutting public employment or the labour income tax rate leads, in contrast, to a lower wage, a higher interest rate and a higher capital stock. Employment rises on impact. If the extra revenues of rolling back the welfare state are handed back via a lower tax rate rather than a lump-sum subsidy, both cutting public employment and cutting public spending on market goods induce an investment boom. Making the tax system less progressive by cutting tax credits and the labour income tax rate induces an investment boom as well. The effects of endogenous growth, adjustment costs for investment and non-Walrasian labour markets on these results are considered as well.
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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number
4896.
Find related papers by JEL classification: D90 - Microeconomics - - Intertemporal Choice and Growth - - - General E20 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - General (includes Measurement and Data) E60 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - General H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
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