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

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Author Info
Kevin Joseph Carey
Evan Tanner

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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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Paper provided by International Monetary Fund in its series IMF Working Papers with number 05/207.

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Length: 32 pages
Date of creation: 16 Nov 2005
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Handle: RePEc:imf:imfwpa:05/207

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Keywords: Taxes ; Economic forecasting ; Fiscal policy ; Production ;

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  3. Jacques Miniane, 2004. "Productivity Shocks, Learning, and Open Economy Dynamics," IMF Working Papers 04/88, International Monetary Fund. [Downloadable!]
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  6. George J. Hall & Stefan Krieger, 2000. "Tax Smoothing Implications of the Federal Debt Paydown," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 31(2000-2), pages 253-302. [Downloadable!]
  7. Reinhart, Carmen & Rogoff, Kenneth & Savastano, Miguel, 2003. "Debt intolerance," MPRA Paper 13932, University Library of Munich, Germany. [Downloadable!]
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  8. Bennett T. McCallum, 2000. "The Present and Future of Monetary Policy Rules," NBER Working Papers 7916, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October. [Downloadable!] (restricted)
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  11. Siu, Henry E., 2004. "Optimal fiscal and monetary policy with sticky prices," Journal of Monetary Economics, Elsevier, vol. 51(3), pages 575-607, April. [Downloadable!] (restricted)
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  14. Michael Kumhof & Evan Tanner, 2005. "Government Debt: A Key Role in Financial Intermediation," IMF Working Papers 05/57, International Monetary Fund. [Downloadable!]
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  16. Kingston, Geoffrey, 1991. "Should Marginal Tax Rates Be Equalized Through Time?," The Quarterly Journal of Economics, MIT Press, vol. 106(3), pages 911-24, August. [Downloadable!] (restricted)
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  22. Dreze, Jacques H. & Modigliani, Franco, 1972. "Consumption decisions under uncertainty," Journal of Economic Theory, Elsevier, vol. 5(3), pages 308-335, December. [Downloadable!] (restricted)
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Strawczynski, Michel & Zeira, Joseph, 2009. "Cyclicality of Fiscal Policy: Permanent and Transitory Shocks," CEPR Discussion Papers 7271, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
  2. Carlos Garcia & Jorge Restrepo & Evan Tanner, 2007. "Designing fiscal rules for commodity exporters," ILADES-Georgetown University Working Papers inv199, Ilades-Georgetown University, School of Economics and Bussines. [Downloadable!]
  3. 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. [Downloadable!]
    Other versions:
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