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From Deficit Delusion to the Fiscal Balance Rule: Looking For an Economically Meaningful Way to Assess Fiscal Policy

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  • Laurence J. Kotlikoff

Abstract

Notwithstanding its widespread use as a measure of fiscal policy, the government deficit is not a well-defined concept from the perspective of neoclassical macro economics. From the neoclassical perspective the deficit is an arbitrary accounting construct whose value depends on how the government chooses to label its receipts and payments. This paper demonstrates the arbitrary nature of government deficits. The argument that the deficit is not well-defined is first framed in a simple certainty model with nondistortionary policies, and then in settings with uncertain policy, distortionary policy, and liquidity constraints. As an alternative to economically arbitrary deficits, the paper indicates that the "Fiscal Balance Rule" is one norm for measuring whether current policy will place a larger or smaller burden on future generations than it does on current generations. The Fiscal Balance Rule is based on the economy's intertemporal budget constraint and appears to underlie actual attempts to run tight fiscal policy. It says take in net present value from each new young generation an amount equal to the flow of government consumption less interest on the difference between a) the value of the economy's capital stock and b) the present value difference between the future consumption and future labor earnings of existing older generations. While the rule is a mouth-full, one can use existing data to check whether it is being obeyed and, therefore, whether future generations are likely to be treated better or worse than current generations.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 2841.

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Date of creation: Feb 1989
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Publication status: published as Laurence J. Kotlikoff, Laurence J. Kotlikoff, Willi Leibfritz. "From Deficit Delusion to the Fiscal Balance Rule: Looking for an Economically Meaningful Way to Assess Fiscal Policy ," in Alan J. Auerbach, Laurence J. Kotlikoff and Willi Leibfritz, editors, "Generational Accounting around the World" University of Chicago Press (1999)
Handle: RePEc:nbr:nberwo:2841

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  1. Fumio Hayashi, 1985. "Tests for Liquidity Constraints: A Critical Survey," NBER Working Papers 1720, National Bureau of Economic Research, Inc.
  2. Kotlikoff, Laurence J, 1984. "Taxation and Savings: A Neoclassical Perspective," Journal of Economic Literature, American Economic Association, vol. 22(4), pages 1576-1629, December.
  3. Joseph G. Altonji & Aloysius Siow, 1986. "Testing the Response of Consumption to Income Changes with (Noisy) PanelData," NBER Working Papers 2012, National Bureau of Economic Research, Inc.
  4. Kotlikoff, Laurence J, 1979. "Social Security and Equilibrium Capital Intensity," The Quarterly Journal of Economics, MIT Press, vol. 93(2), pages 233-53, May.
  5. Martin Feldstein, 1983. "Behavioral Simulation Methods in Tax Policy Analysis," NBER Books, National Bureau of Economic Research, Inc, number feld83-2, October.
  6. Laitner, John, 1990. "Tax Changes and Phase Diagrams for an Overlapping Generations Model," Journal of Political Economy, University of Chicago Press, vol. 98(1), pages 193-220, February.
  7. Christophe Chamley, 1980. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Cowles Foundation Discussion Papers 553, Cowles Foundation for Research in Economics, Yale University.
  8. Feldstein, Martin (ed.), 1983. "Behavioral Simulation Methods in Tax Policy Analysis," National Bureau of Economic Research Books, University of Chicago Press, edition 0, number 9780226240848, Winter.
  9. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
  10. Eisner, Robert & Pieper, Paul J, 1986. "A New View of the Federal Debt and Budget Deficits: Reply," American Economic Review, American Economic Association, vol. 76(5), pages 1156-57, December.
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Cited by:
  1. Ferhan Salman, 2004. "Balancing Turkey’s Intertemporal Budget Gap," Working Papers 0408, Research and Monetary Policy Department, Central Bank of the Republic of Turkey.
  2. Buiter, Willem H, 1996. "Aspects of Fiscal Performance in some Transition Economies under Fund-supported Programs," CEPR Discussion Papers 1535, C.E.P.R. Discussion Papers.
  3. Willem H. Buiter, 1993. "Public Debt in the USA: How Much, How Bad and Who Pays?," NBER Working Papers 4362, National Bureau of Economic Research, Inc.
  4. Ionut Dumitru & Razvan Stanca, 2011. "Fiscal discipline and economic growth – the case of Romania," Advances in Economic and Financial Research - DOFIN Working Paper Series 50, Bucharest University of Economics, Center for Advanced Research in Finance and Banking - CARFIB.
  5. Jagadeesh Gokhale & Laurence J. Kotlikoff & John Sabelhaus, 1996. "Understanding the Postwar Decline in U.S. Saving: A Cohort Analysis," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 27(1), pages 315-407.
  6. Koch, Daniel, 2011. "Wirksame Begrenzung von Staatsverschuldung auf europäischer Ebene," Wirtschaftswissenschaftliche Beiträge 114, Julius-Maximilians-Universität Würzburg, Lehrstuhl für Volkswirtschaftslehre, insbes. Wirtschaftsordnung und Sozialpolitik.
  7. Syed Ahsan & Peter Tsigaris, 1998. "The design of a consumption tax under capital risk," Journal of Economics, Springer, vol. 68(1), pages 53-78, February.
  8. Walliser, Jan, 1999. "Would Saving Social Security Raise National Saving?," National Tax Journal, National Tax Association, vol. 52(n. 3), pages 541-52, September.
  9. Syed M. Ahsan & Panagiotis Tsigaris, 2003. "Choice of Tax Base Revisited: Cash Flow vs. Prepayment Approaches to Consumption Taxation," CESifo Working Paper Series 983, CESifo Group Munich.
  10. Alvaro Montenegro, 2004. "Lectura de la estadística fiscal," DOCUMENTOS DE ECONOMÍA 003137, UNIVERSIDAD JAVERIANA - BOGOTÁ.
  11. Jagadeesh Gokhale & Laurence J. Kotlikoff & John Sabelhaus, 1995. "Understanding the postwar decline in United States saving: a cohort analysis," Working Paper 9518, Federal Reserve Bank of Cleveland.
  12. Willem H. Buiter, 1995. "Generational Accounts, Aggregate Saving and Intergenerational Distribution," NBER Working Papers 5087, National Bureau of Economic Research, Inc.
  13. Marco Bassetto & Narayana Kocherlakota, 2010. "On the Irrelevance of Government Debt When Taxes are Distortionary," Levine's Working Paper Archive 506439000000000295, David K. Levine.
  14. Alan Auerbach & Bruce Baker & Laurence Kotlikoff & Jan Walliser, 1997. "Generational Accounting in New Zealand: Is There Generational Balance?," International Tax and Public Finance, Springer, vol. 4(2), pages 201-228, May.
  15. Henrik Petersen, Jorn, 1998. "Recent research on public pension systems. A review," Labour Economics, Elsevier, vol. 5(1), pages 91-108, March.

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