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Model uncertainty and intertemporal tax smoothing

  • Yulei Luo
  • Jun Nie
  • Eric R. Young

In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and debt structure in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB can improve the model’s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending and (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits.

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Paper provided by Federal Reserve Bank of Kansas City in its series Research Working Paper with number RWP 12-01.

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Date of creation: 2012
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Handle: RePEc:fip:fedkrw:rwp12-01
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