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On the Optimality of U.S. Fiscal Policy: 1960-2010

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  • Ortigueira, Salvador

Abstract

This paper assesses the optimality of U.S. fiscal policy from 1960 to 2010. With this purpose, we present a tractable neoclassical economy with a benevolent government and characterize time-consistent, optimal fiscal policy. We then compare the model's prescriptions for income tax rates and government expenditure with their empirical counterparts observed in the U.S. in this period. We find that U.S. income taxation and government consumption expenditure were in line with the model's prescriptions from 1960 to 2000. However, starting in the early 2000s and for the rest of the decade, U.S. fiscal policy trended in a direction opposite to that of the optimal policy prescribed by the model. In particular, U.S. income tax rates declined below their optimal rates, and government consumption expenditures as a share of GDP sharply increased above their optimal levels. By way of example, while our model prescribes a 10% reduction in the government consumption expenditure-to-GDP ratio between 2001 and 2010, the U.S. ratio increased by 23% in this period.

Suggested Citation

  • Ortigueira, Salvador, 2014. "On the Optimality of U.S. Fiscal Policy: 1960-2010," UC3M Working papers. Economics we1418, Universidad Carlos III de Madrid. Departamento de Economía.
    • Handle: RePEc:cte:werepe:we1418
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    References listed on IDEAS

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    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H24 - Public Economics - - Taxation, Subsidies, and Revenue - - - Personal Income and Other Nonbusiness Taxes and Subsidies
    • H40 - Public Economics - - Publicly Provided Goods - - - General
    • H50 - Public Economics - - National Government Expenditures and Related Policies - - - General

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