Fiscal policy, employment by age, and growth in OECD economies

We build and parameterize a general equilibrium OLG model for an open economy to study hours of work in three age groups, education of the young, and aggregate per capita growth. The composition of fiscal policy plays a crucial role. The government sets tax rates on labor, capital and consumption. It allocates its revenue to productive expenditures (mainly for education), consumption and ‘non-employment’ benefits. Labor taxes and benefits may differ across age groups. We find that our model’s predictions match the facts remarkably well for all key variables in many OECD countries. We then use the model to investigate the effects of various fiscal policy shocks on employment by age and growth, as well as on welfare of current and future generations. We identify ‘non-employment’ benefits and labor taxes as the main policy variables affecting employment. Productive government expenditures are the most effective with respect to long-run output and growth. Long-run output and growth may benefit also from labor tax cuts targeted at older workers. Considering welfare effects, however, these policy measures may not be the ones preferred most by current generations.