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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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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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Find related papers by JEL classification:
  • D61 - Microeconomics - - Welfare Economics - - - Allocative Efficiency; Cost-Benefit Analysis
  • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
  • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy

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Cited by:

  1. Philippe D Karam & Douglas Hostland, 2005. "Assessing Debt Sustainability in Emerging Market Economies Using Stochastic Simulation Methods," IMF Working Papers 05/226, International Monetary Fund.
  2. Garcia, Carlos J. & Restrepo, Jorge E. & Tanner, Evan, 2011. "Fiscal rules in a volatile world: A welfare-based approach," Journal of Policy Modeling, Elsevier, vol. 33(4), pages 649-676, July.
  3. Bernardo Maggi, 2015. "(Why) Is the Euro system intrinsically unstable?," DSS Empirical Economics and Econometrics Working Papers Series 2015/1, Centre for Empirical Economics and Econometrics, Department of Statistics, "Sapienza" University of Rome.
  4. 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.
  5. Strawczynski, Michel & Zeira, Joseph, 2009. "Cyclicality of Fiscal Policy: Permanent and Transitory Shocks," CEPR Discussion Papers 7271, C.E.P.R. Discussion Papers.
  6. International Monetary Fund, 2008. "Jamaica; Selected Issues," IMF Staff Country Reports 08/198, International Monetary Fund.
  7. Evan C Tanner, 2013. "Fiscal Sustainability; A 21st Century Guide for the Perplexed," IMF Working Papers 13/89, International Monetary Fund.

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