Ebook Strategic Behavior, Debt Neutrality and Crowding Out
Interest in the effects of government budget deficits waned in the late 1990’s as deficits in many countries substantially declined. There is adequate empirical evidence that government debt has real effects, and an assortment of suspected causes, but little agreement on the significance of its failure. The recent resurgence of significant fiscal deficits in many countries should motivate additional work on this topic.
Previous research indicates a sizeable portion of wealth is accumulated out of a desire to leave intergenerational bequests; less clear is the exact motive for these bequests. The impact of government deficits likely depends strongly on the exact nature of intergenerational relationships, a fact highlighted in Cremer and Pestieau (2003) and Kaplow (2001). I employ a little-studied version of intergenerational relationships to show that the effects of some fiscal policies can be quite sensitive to the nature of these relationships while other policies are neutral. Specifically, deficit financing is neutral when taxes are lump sum but, when using capital gains and inheritance taxes, crowding out is significantly smaller in versions of the model with strategic behavior than in one without strategic behavior.
Previous works present mixed results on the significance of intergenerational strategic behavior in determining the effect of fiscal policy changes. For example, Bruce and Waldman (1990) and Kotlikoff, Razin, and Rosenthal (1990) conclude government debt is not neutral in their respective static environments. Seater (1993) writes that when strategic behavior is included in parent-child interactions “a debt-for-tax swap alters the threat point of the parents and/or the children and therefore has real effects, negating Ricardian equivalence.” (Seater 1993, 148). On the other hand, Bernheim and Bagwell (1988) conclude debt is neutral regardless of the nature of the intrafamily relationships. Seater, in a review of the Ricardian equivalence literature, finds only a handful of authors who attempt to make any connection between strategic behavior and Ricardian equivalence. One result of this paper is to demonstrate that intergenerational strategic behavior, by itself, does not necessarily cause Ricardian equivalence to fail.
General equilibrium analyses that include strategic behavior seldom examine Ricardian equivalence. The few exceptions include Nishiyama (2002), Gale and Perozek (2001), Smetters (1999), and Bernheim and Bagwell (1988). The model used by Nishiyama is similar to one of the specifications used in this paper, but the analysis simply compares macro aggregates before and after a policy change. The analysis of Gale and Perozek employs the form of strategic behavior studied here, but only does so in a partial-equilibrium framework. Smetters uses a general equilibrium framework to demonstrate the neutrality of some types of strategic behavior, but omits discussion of the form studied in this paper. Bernheim and Bagwell extend Barro’s dynastic framework to extremes by asserting everyone is in fact connected through possible future marriages and through transfers to siblings, cousins, and charities (fn. 23). Their result that “everything is neutral” is certainly untenable (as they point out) and may stem in part from their assertion that uncertainty about potential future connections is irrelevant.
I model the interaction between an altruistic parent and a selfish child as a form of the Samaritan’s dilemma. An altruistic parent makes an end-of-life transfer to a selfish child. The child can attempt to elicit as large a transfer as possible from the parent by overconsuming when young. The parent faces the problem of the good Samaritan: how to help his selfish child without being exploited. Successful manipulation by the child alters the margins at which decisions are made so the parent saves and transfers different amounts than he would without the strategic behavior. I show that, in spite of the altered decision margins, Ricardian equivalence continues to hold in this framework.
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