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Lack of Commitment, Retroactive Tax Changes, and Macroeconomic Instability

Author

Listed:
  • Salvador Ortigueira

    (Economics Department University of Miami)

  • Joana Pereira

    (IMF)

Abstract

It is not uncommon that tax reform laws contain retroactive provisions. In this paper we are concerned with the fiscal and macroeconomic consequences of the constitutional ability of the government to retroactively revoke pre-announced income taxes. To this end, we study time-consistent optimal fiscal policy in a neoclassical economy where the government chooses the level of expenditure in a public good, debt issues and income taxation. When the government lacks commitment to these three fiscal variables, a complementarity between the decisions of the households and the government emerges, generating a multiplicity of expectations-driven equilibria. That is, fiscal policy is not uniquely pinned down by economic fundamentals, but it is determined by households' expectations about current and future policies. Accordingly, economies with identical fundamentals may display significantly different fiscal policies, consumption and investment.

Suggested Citation

  • Salvador Ortigueira & Joana Pereira, 2016. "Lack of Commitment, Retroactive Tax Changes, and Macroeconomic Instability," Working Papers WP2016-05, University of Miami, Department of Economics.
    • Handle: RePEc:mia:wpaper:2016-05
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    File URL: https://www.herbert.miami.edu/_assets/files/repec/WP2016-05.pdf
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    References listed on IDEAS

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    Cited by:

    1. Camous, Antoine & Gimber, Andrew R., 2018. "Public debt and fiscal policy traps," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 239-259.

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    More about this item

    Keywords

    Retroactive Taxation; Expectation Traps; Equilibrium Multiplicity Publication Status:;
    All these keywords.

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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