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Policy and welfare effects of within-period commitment

  • Fernando M. Martin

I study the implications of different institutional frameworks for the conduct of fiscal policy, under the assumption that the government cannot commit to future policy choices. The environments analyzed vary on whether the government is endowed with the ability to commit to beginning-of-period policy announcements or not. If it cannot, then there are two variants, depending on which actions private agents take before observing the government’s policy choice. How the three possible cases rank in terms of tax rates and welfare varies substantially with the economy’s fundamentals and whether depreciation is tax deductible or not. More generally, I find that regimes with higher tax rates do not necessarily imply lower welfare. I also find that making depreciation not tax-deductible typically involves a welfare loss. Within the context of the environments studied in this paper, I find that there are only small gains from modifying the way fiscal policy is conducted in modern developed economies. Furthermore, some reforms may lead to large welfare losses.

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Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2011-031.

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Date of creation: 2011
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Handle: RePEc:fip:fedlwp:2011-031
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  1. Fernando M. Martin, 2004. "A Positive Theory of Government Debt," Macroeconomics 0408013, EconWPA, revised 12 Oct 2004.
  2. Salvador Ortigueira & Joana Pereira & Paul Pichler, 2012. "Markov-perfect optimal fiscal policy : the case of unbalanced budgets," Economics Working Papers we1230, Universidad Carlos III, Departamento de Economía.
  3. David R. Stockman, 2001. "Balanced-Budget Rules: Welfare Loss and Optimal Policies," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 4(2), pages 438-459, July.
  4. Salvador Ortigueira, 2006. "Markov-Perfect Optimal Taxation," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 9(1), pages 153-178, January.
  5. Azzimonti, Marina & Sarte, Pierre-Daniel & Soares, Jorge, 2009. "Distortionary taxes and public investment when government promises are not enforceable," Journal of Economic Dynamics and Control, Elsevier, vol. 33(9), pages 1662-1681, September.
  6. Guo, Jang-Ting & Lansing, Kevin J., 1999. "Optimal taxation of capital income with imperfectly competitive product markets," Journal of Economic Dynamics and Control, Elsevier, vol. 23(7), pages 967-995, June.
  7. Pecorino, Paul, 1993. "Tax structure and growth in a model with human capital," Journal of Public Economics, Elsevier, vol. 52(2), pages 251-271, September.
  8. Cohen, Daniel & Michel, Philippe, 1988. "How Should Control Theory Be Used to Calculate a Time-Consistent Government Policy?," Review of Economic Studies, Wiley Blackwell, vol. 55(2), pages 263-74, April.
  9. Martin, Fernando M., 2010. "Markov-perfect capital and labor taxes," Journal of Economic Dynamics and Control, Elsevier, vol. 34(3), pages 503-521, March.
  10. Christopher Phelan & Ennio Stacchetti, 1999. "Sequential equilibria in a Ramsey tax model," Staff Report 258, Federal Reserve Bank of Minneapolis.
  11. Fernando Martin, 2009. "On the Joint Determination of Fiscal and Monetary Policy," Discussion Papers dp09-01, Department of Economics, Simon Fraser University.
  12. Jan-Ting Guo & Kevin J. Lansing, 1997. "Tax structure and welfare in a model of optimal fiscal policy," Economic Review, Federal Reserve Bank of Cleveland, issue Q I, pages 11-23.
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