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The Sustainability of Budget Deficits with Lump-Sum and with Income-Based Taxation

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  • Bohn, Henning

Abstract

The paper examines the substantiality of fiscal policies in a stochastic economy with a particular focus on two benchmark policies, balanced budgets and tax smoothing. These policies are typically sustainable if lump-sum taxes are available, but they are generally not sustainable in a stochastic environment, if taxation is constrained by the size of the economy. The sustainability problems arise because the debt-income ratio becomes excessive whenever there are sufficiently low realizations of aggregate income. I also compute the probability of reaching high debt-income ratios with different policies and I discuss the role of debt management for sustainability. It turns out that balanced budgets can be sustained forever with very high probability (but less than one), but so can policies with permanent primary or with-interest deficits. I argue that debt management is important for sustainability in a stochastic environment and show that the use state-contingent government liabilities can be helpful in designing sustainable versions of tax-smoothing and balanced budget policies.
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  • Bohn, Henning, 1991. "The Sustainability of Budget Deficits with Lump-Sum and with Income-Based Taxation," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 23(3), pages 580-604, August.
  • Handle: RePEc:mcb:jmoncb:v:23:y:1991:i:3:p:580-604
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    Cited by:

    1. Viviane Luporini, 1999. "Federal domestic debt in Brazil: 1981-1996," Textos para Discussão Cedeplar-UFMG td128, Cedeplar, Universidade Federal de Minas Gerais.
    2. Afonso, António & Agnello, Luca & Furceri, Davide & Sousa, Ricardo M., 2011. "Assessing long-term fiscal developments: A new approach," Journal of International Money and Finance, Elsevier, vol. 30(1), pages 130-146, February.
    3. Bodo HERZOG, "undated". "European Monetary Union and Fiscal Policy Sustainability," EcoMod2004 330600067, EcoMod.
    4. Togo, Eriko, 2007. "Coordinating public debt management with fiscal and monetary policies : an analytical framework," Policy Research Working Paper Series 4369, The World Bank.
    5. Ball, Laurence & Elmendorf, Douglas W & Mankiw, N Gregory, 1998. "The Deficit Gamble," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 30(4), pages 699-720, November.
    6. Christian Schoder, 2014. "The fundamentals of sovereign debt sustainability: evidence from 15 OECD countries," Empirica, Springer;Austrian Institute for Economic Research;Austrian Economic Association, vol. 41(2), pages 247-271, May.
    7. Cuddington, John T., 1997. "Analyzing the sustainability of fiscal deficitsin developing countries," Policy Research Working Paper Series 1784, The World Bank.
    8. Pierre-Yves Hénin, 1997. "Soutenabilité des déficits et ajustements budgétaires," Revue Économique, Programme National Persée, vol. 48(3), pages 371-395.
    9. Lloyd-Ellis, Huw & Zhu, Xiaodong, 2001. "Fiscal shocks and fiscal risk management," Journal of Monetary Economics, Elsevier, vol. 48(2), pages 309-338, October.
    10. Mário Jorge Cardoso de Mendonça & Cláudio Hamilton Matos dos Santos, 2008. "Revisitando a Função de Reação Fiscal no Brasil Pós-Real: Uma Abordagem de Mudanças de Regime," Anais do XXXVI Encontro Nacional de Economia [Proceedings of the 36th Brazilian Economics Meeting] 200807171729460, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
    11. Viviane Luporini, 2001. "The behavior of the Brazilian federal domestic debt," Textos para Discussão Cedeplar-UFMG td161, Cedeplar, Universidade Federal de Minas Gerais.
    12. António Afonso & João Tovar Jalles, 2012. "Revisiting fiscal sustainability: panel cointegration and structural breaks in OECD countries," Working Papers Department of Economics 2012/29, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    13. Cláudio Hamilton dos Santos & Márcio Bruno Ribeiro & Sérgio Wulff Gobetti, 2008. "A Evolução da Carga Tributária Bruta Brasileira no Período 1995-2007: Tamanho, Composição e Especificações Econométricas Agregadas," Discussion Papers 1350, Instituto de Pesquisa Econômica Aplicada - IPEA.
    14. Atrayee Ghosh Roy & Hendrik Van den Berg, 2009. "Budget deficits and U.S. economic growth," Economics Bulletin, AccessEcon, vol. 29(4), pages 3015-3030.
    15. Barbie, Martin & Hagedorn, Marcus & Kaul, Ashok, 2001. "Government Debt as Insurance against Macroeconomic Risk," IZA Discussion Papers 412, Institute for the Study of Labor (IZA).
    16. Sakuragawa, Masaya & Hosono, Kaoru, 2011. "Fiscal sustainability in Japan," Journal of the Japanese and International Economies, Elsevier, vol. 25(4), pages 434-446.
    17. Otto, Glenn & Voss, Graham M., 1995. "Consumption, external assets and the real interest rate," Journal of Macroeconomics, Elsevier, vol. 17(3), pages 471-494.
    18. António Afonso, 2000. "Fiscal policy sustainability: some unpleasant European evidence," Working Papers Department of Economics 2000/12, ISEG - Lisbon School of Economics and Management, Department of Economics, Universidade de Lisboa.
    19. Green, Christopher J. & Holmes, Mark J. & Kowalski, Tadeusz, 2001. "Poland: a successful transition to budget sustainability?," Emerging Markets Review, Elsevier, vol. 2(2), pages 161-183, June.
    20. Viviane Luporini, 2000. "Further investigation into the sustainability of the brazilian federal domestic debt," Textos para Discussão Cedeplar-UFMG td131, Cedeplar, Universidade Federal de Minas Gerais.
    21. Viviane Luporini, 1999. "Sustainability of the Brazilian fiscal policy and central bank independence," Textos para Discussão Cedeplar-UFMG td125, Cedeplar, Universidade Federal de Minas Gerais.

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