Abstract
In this paper we study the taxes vs. debt choice for public funding when spending is in large part predictable due to entitlement programs, but the necessary fiscal corrections may not be instantly and indefinitely elastic as usually assumed. We study fiscal behavior in a large sample of countries to determine what fiscal regimes have been used in practice, and what they reveal about the trade-off between raising taxes vs. issuing debt. Unsurprisingly, we find that fiscal discipline and the aims of fiscal rules have varied over the past 50 years. Discipline has generally weakened and there has been a greater tendency to use debt. But governments are no less forward looking than they were. Perhaps more surprising, the high debt countries were more disciplined than low debt economies—but with worse outcomes because of their poor starting positions and more persistent public spending. The low debt countries have exploited their stronger initial position to allow less discipline; a “resting on one’s laurels” approach.
Highlights
The standard analysis of public debt management traditionally assumes that spending liabilities only enter into public debt calculations as current liabilities
We study fiscal behavior in a large sample of countries to determine what fiscal regimes have been used in practice, and what they reveal about the trade-off between raising taxes vs. issuing debt
Any costs induced by rising debt must be internalized by the government: both where financial stress is caused by anticipated risk premia or where policymakers are elected by voters who are averse to public debt
Summary
The standard analysis of public debt management traditionally assumes that spending liabilities only enter into public debt calculations as current liabilities. We estimate the model for a large sample of countries using panel data techniques, and we repeat the analysis for different time periods, to check if and how preferences have changed over time. Governments have actively encouraged, or at least accommodated, loose tax policies that may deviate from their target paths because they have benefited from weak penalties on the use of debt. They have encouraged tax smoothing in fiscal management. For the high debt countries we find that taxes have been used to smooth fiscal policies and consolidation in a more disciplined way in all periods, more so than in the low debt economies, and that debt has been more disciplined in all periods.
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