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

In: Generational Accounting around the World

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  • Laurence J. Kotlikoff
  • Laurence J. Kotlikoff
  • Willi Leibfritz

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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Suggested Citation

  • Laurence J. Kotlikoff & Laurence J. Kotlikoff & Willi Leibfritz, 1999. "From Deficit Delusion to the Fiscal Balance Rule: Looking for an Economically Meaningful Way to Assess Fiscal Policy," NBER Chapters,in: Generational Accounting around the World, pages 9-30 National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:6683
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    1. Kotlikoff, Laurence J, 1984. "Taxation and Savings: A Neoclassical Perspective," Journal of Economic Literature, American Economic Association, vol. 22(4), pages 1576-1629, December.
    2. Thomas J. Sargent & Neil Wallace, 1981. "Some unpleasant monetarist arithmetic," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Fall.
    3. Joseph G. Altonji & Aloysius Siow, 1987. "Testing the Response of Consumption to Income Changes with (Noisy) Panel Data," The Quarterly Journal of Economics, Oxford University Press, vol. 102(2), pages 293-328.
    4. Chamley, Christophe, 1981. "The Welfare Cost of Capital Income Taxation in a Growing Economy," Journal of Political Economy, University of Chicago Press, vol. 89(3), pages 468-496, June.
    5. Feldstein, Martin S, 1974. "Social Security, Induced Retirement, and Aggregate Capital Accumulation," Journal of Political Economy, University of Chicago Press, vol. 82(5), pages 905-926, Sept./Oct.
    6. Martin Feldstein, 1983. "Behavioral Simulation Methods in Tax Policy Analysis," NBER Books, National Bureau of Economic Research, Inc, number feld83-2.
    7. Feldstein, Martin (ed.), 1983. "Behavioral Simulation Methods in Tax Policy Analysis," National Bureau of Economic Research Books, University of Chicago Press, number 9780226240848, October.
    8. Laurence J. Kotlikoff, 1979. "Social Security and Equilibrium Capital Intensity," The Quarterly Journal of Economics, Oxford University Press, vol. 93(2), pages 233-253.
    9. Michael J. Boskin & Marc S. Robinson & Alan M. Huber, 1987. "Government Saving, Capital Formation and Wealth in the United States, 1947-1985," NBER Working Papers 2352, National Bureau of Economic Research, Inc.
    10. Fumio Hayashi, 1985. "Tests for Liquidity Constraints: A Critical Survey," NBER Working Papers 1720, National Bureau of Economic Research, Inc.
    11. 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.
    12. 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 1156-1157, December.
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