Short-run fiscal policy: Welfare, redistribution and aggregate effects in the short and long-run

Abstract

This paper quantifies the effects of two short-run fiscal policies, a temporary tax-cut and rebate transfer, that are intended to stimulate economic activities. A reduction in income taxation provides immediate incentives to work and save more, raising aggregate output and consumption. A temporary rebate is mostly saved and increases consumption marginally. Both policies improve the overall welfare of households and the rebate policy benefits especially low-income households. In the long-run, however, the debt accumulated to finance the stimulus and a higher tax to service the debt can crowd out capital and lower output and consumption, causing welfare to deteriorate.