nep-pub New Economics Papers
on Public Finance
Issue of 2007‒09‒16
eight papers chosen by
Kwang Soo Cheong
Johns Hopkins University

  1. Capital Taxation and Ownership when Markets are Incomplete By Emmanuel Farhi
  2. VAT Attacks! By Michael Keen
  3. The Value-Added Tax: Its Causes and Consequences By Ben Lockwood; Michael Keen
  4. Optimal taxation with imperfect competition and aggregate returns to specialization By Javier Coto-Martínez; Carlos Garriga; Fernando Sánchez-Losada
  5. The Basic Public Finance of Public-Private Partnerships By Eduardo Engel; Ronald Fischer; Alexander Galetovic
  6. What Has Financed Government Debt? By Hess Chung; Eric Leeper
  7. A Note on Public Debt, Tax-Exempt Bonds, and Ponzi Games By Berthold U. Wigger
  8. Optimal fiscal policy in the design of Social Security reforms By Juan Carlos Conesa; Carlos Garriga

  1. By: Emmanuel Farhi
    Abstract: This paper analyzes the theoretical and quantitative implications of optimal capital taxation in the neoclassical growth model with aggregate shocks and incomplete markets. The model features a representative-agent economy with proportional taxes on labor and capital. I first consider the case that the only asset the government can trade is a real risk-free bond. Taxes on capital are set one period in advance, reflecting inertia in tax codes and ruling out replication of the complete markets allocation. Because capital income varies with the state of the economy, capital taxation provides a state contingent source of revenues. I thus identify a novel potential role for capital taxation as a risk sharing instrument between the government and private agents. However, this benefit must be weighted again the distortionary cost of capital taxation. For a baseline case, the optimal policy features a zero tax on capital. Moreover, numerical simulations show that the baseline case provides an excellent benchmark. I next allow the government to hold a non trivial position in capital. Capital ownership provides the same benefit or risk sharing but without the cost of tax distortions. In a variety of quantitative exercises, I show that capital ownership allows the government to realize about 90% of the welfare gains from moving to complete markets. Large positions are typically required for optimality. But smaller positions achieve substantial benefits. In a business-cycle simulation, I show that a 15% short equity position achieves over 40% of the welfare gains from completing markets.
    JEL: A1 E21 E22 E23 E6 E60 E62 E66 H21 H3 H31 H32 H6 H60 H61 H62
    Date: 2007–09
  2. By: Michael Keen
    Abstract: Like the theory of the second best that the 2006 congress marks, the VAT is now fifty years old. Judged by the extent and speed of its spread around the world, and the revenue that it raises, the VAT would seem to have been a remarkable success. Over the last few years, however, it has come under a series of attacks. This paper considers three of the most prominent of these. One is the fear (raised mainly in the United States) that the VAT actually does too good a job of raising tax revenue. The second is the view that the VAT does a bad job of taxing the informal sector-and that tariffs might be a better revenue-raising instrument for many developing countries. The third attack is the most literal, by criminals rather than theorists: in the European Union and elsewhere, sophisticated VAT fraud, targeting its refund provisions, has become a serious concern.
    Keywords: Working Paper , Value added tax , Tax reforms , Indirect taxation ,
    Date: 2007–06–28
  3. By: Ben Lockwood; Michael Keen
    Abstract: Has the VAT proved, as its proponents claim, an especially effective form of taxation? To address this, this paper first shows that a tax innovation-such as the introduction of a VAT- reduces the marginal cost of public funds if and only if it also leads an optimizing government to increase the tax ratio. This leads to the estimation, on a large panel, of a system of equations describing the probability of VAT adoption and the revenue impact of the VAT. The sign of the revenue impact is generally ambiguous, but most countries that have adopted a VAT seem to have gained a more effective tax instrument in doing so.
    Date: 2007–07–24
  4. By: Javier Coto-Martínez; Carlos Garriga; Fernando Sánchez-Losada
    Abstract: In this paper we explore the proposition that in economies with imperfect competitive markets the optimal capital income tax is negative and the optimal tax on rms prots is conscatory. We show that if the total factor productivity as well as the measure of rms or varieties are endogenous instead of xed, then the optimal scal policy can lead to di_erent results. The government faces a trade-o_ between the xed costs that society pays for the introduction of a new rm and the productivity gains associated to the introduction of a new variety. We nd that the optimal scal policy depends on the relationship between the index of market power, the returns to specialization, and the governments ability to control entry.
    Keywords: Taxation ; Fiscal policy
    Date: 2007
  5. By: Eduardo Engel; Ronald Fischer; Alexander Galetovic
    Abstract: Public-private partnerships (PPPs) cannot be justified because they free public funds. When PPPs are desirable because the private sector is more efficient, the contract that optimally trades demand risk, user-fee distortions and the opportunity cost of public funds is characterized by a minimum revenue guarantee and a cap on the firm’s revenues. Yet income guarantees and revenue sharing arrangements observed in practice differ fundamentally from those suggested by the optimal contract. The optimal contract can be implemented via a competitive auction with realistic informational requirements; and risk allocation under the optimal contract suggests that PPPs are closer to public provision than to privatization. JEL classification: H21, H54, L51, R42.
    Date: 2007
  6. By: Hess Chung (Indiana University Bloomington); Eric Leeper (Indiana University Bloomington)
    Abstract: Equilibrium models imply that the real value of debt in the hands of the public must equal the expected present-value of surpluses. Empirical models of fiscal policy typically do not impose this condition and often do not even include debt. Absence of debt from empirical models can produce non-invertible representations, obscuring the true present-value relation, even if it holds in the data. First, we show that small VAR models of fiscal policy may not be invertible and that expanding the information set to include government debt has quantitatively important implications. Then we impose the present-value condition on an identified VAR and characterize the way in which the present-value support of debt varies across types of fiscal shocks. The role of expected primary surpluses in supporting innovations to debt depends on the nature of the shock. Debt is supported almost entirely by changes in the present-value of surpluses for some fiscal shocks, but for other fiscal shocks surpluses fail to adjust, leaving a large role for expected changes in discount rates. Horizons over which debt innovations are financed are long---on the order of 50 years or more.
    Keywords: fiscal policy, present-value restriction, taxes, government spending
    JEL: E6
    Date: 2007–09
  7. By: Berthold U. Wigger
    Abstract: By issuing tax-exempt bonds, the government can incur debt and never pay back any principal or interest, even if the economy without public debt evolves on a dynamically efficient growth path. The welfare effects of such a Ponzi type borrowing scheme are mixed. The current young will unambiguously benefit.Depending on preferences and the aggregate technology, also a finite number of subsequent generations may benefit. The welfare of all generations thereafter, however, will be lower than in the economy without public debt.
    Date: 2007–07–17
  8. By: Juan Carlos Conesa; Carlos Garriga
    Abstract: The quantitative macroeconomics literature has documented that in the basic Overlapping Generations model a privatization of the social security system, going from a Pay-As-You-Go to a Fully Funded system, generates large long run welfare gains at the cost of substantial welfare losses for initial generations. We propose an alternative to previous literature. In this paper we maximize over the entire policy space, following the optimal fiscal policy approach, rather than comparing alternative policy paths one to one. That is, policies are chosen as part of the optimal design of a social security privatization in a Pareto improving way. The government decides endogenously how to finance the implicit social security liabilities and compensate the initial generations alive during the transition. In contrast with previous analysis the resulting allocation, by construction, lies on the constrained Pareto frontier. We find that the optimal design of reforms exhibits sizeable welfare gains, arising because of the reduction in labor supply distortions. In contrast, the welfare gains coming from the reduction of savings distortions are relatively small.
    Keywords: Fiscal policy ; Social security
    Date: 2007

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