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Comparing budget repair measures for a small open economy with growing debt

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Listed:
  • George Kudrna
  • Chung Tran

Abstract

In this study, we quantify the macroeconomic and welfare effects of alternative fiscal consolidation plans in the context of a small open economy. Using a computable overlapping generations model tailored to the Australian economy, we examine immediate and gradual eliminations of the existing fiscal deficit with (i) temporary income tax hikes, (ii) temporary consumption tax hikes and (iii) temporary transfer payment cuts. The simulation results indicate that all three examined fiscal measures result in favourable long-run macroeconomic and welfare outcomes, but have adverse consequences in the short run that are particularly severe under the immediate fiscal consolidation plan. Moreover, our results show that cutting transfer payments leads to the worst welfare outcome for all generations currently alive, and especially the poor. Increasing the consumption tax rate results in smaller welfare losses, but compared to raising income taxes, the current poor households pay much larger welfare costs. Overall, the welfare trade-offs between current and future generations, as well as between the rich and poor, highlight key political constraints and point to challenging policy choices for the wellbeing of future generations.

Suggested Citation

  • George Kudrna & Chung Tran, 2016. "Comparing budget repair measures for a small open economy with growing debt," CAMA Working Papers 2016-73, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
  • Handle: RePEc:een:camaaa:2016-73
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    File URL: https://cama.crawford.anu.edu.au/sites/default/files/publication/cama_crawford_anu_edu_au/2016-12/73_2016_kudrna_tran.pdf
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    References listed on IDEAS

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    More about this item

    Keywords

    Fiscal Deficit; Public Debt; Fiscal Consolidation; Welfare; Dynamic General Equilibrium; Small Open Economy;

    JEL classification:

    • C68 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computable General Equilibrium Models
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
    • E63 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Comparative or Joint Analysis of Fiscal and Monetary Policy; Stabilization; Treasury Policy
    • H31 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - Household
    • H60 - Public Economics - - National Budget, Deficit, and Debt - - - General
    • J26 - Labor and Demographic Economics - - Demand and Supply of Labor - - - Retirement; Retirement Policies

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