Tax Cuts, Redistribution, and Borrowing Constraints Tommaso - - PowerPoint PPT Presentation

Tax Cuts, Redistribution, and Borrowing Constraints

Tommaso Monacelli (Bocconi, IGIER and CEPR), Roberto Perotti (Bocconi, IGIER, CEPR and NBER), Fiscal and Monetary Policy Challenges in the Short and Long Run, Hamburg May 19-20, 2011

Recent debate on the …scal stimulus

I Higher spending vs. lower taxes I Tax changes: pro-poor or pro-rich?

Conventional wisdom

• 1. Lower taxes better because no implementation lags
• 2. But e¤ect on private spending can be minimal if households

decide to save

• 3. In a recession, should redistribute in favor of low-income

agents, because higher MPC

MPC higher for low income agents: evidence

I MPC out of transitory income shocks (Parker 1999,

McCarthy 1995, Dynan, Skinner and Zeldes 2001)

I Tax rebates (Parker 1999, Souleles 1999, Shapiro and

Slemrod 2003, Johnson, Parker and Souleles 2006).

More general questions

• 1. What are the aggregate e¤ects of redistributing income?
• 2. Are e¤ects of progressive tax cuts di¤erent from e¤ects of

regressive cuts?

I Rarely addressed in a general equilibrium macroeconomic

model

Tax redistributions: a …rst look at the data

I Each US tax bill since 1945 I Assemble data on the level and composition of four

categories of taxes

• 1. personal income taxes
• 2. corporate income taxes
• 3. indirect taxes
• 4. social security taxes

Distributional impact of Personal Income Taxes

• 1. Employ original documentation by the Joint Committee of

Taxation

• 2. Provide narrative estimate of how each tax bill impacts on

the taxes paid by individuals in each income bracket

• 3. Data on the IRS Statistics on Income ! estimate the

number of individuals in each tax bracket, and the total income in each tax bracket.

I Measure how much of the total change in taxes from a given

tax bill will be borne by each decile or quartile of income.

Reagan 1981 Tax Cut

Clinton 1993 Tax Increase

Bush 2001 Tax Cut

Bush 2003 Tax Cut

"Poor-biased" tax change

I The …rst two quartiles pay more than 50 percent of the

increase in taxes (or bene…t for more than 50 percent of the decline in taxes).

Some theory

Our approach

• 1. Heterogenous agents: patient vs. impatient
• 2. Impatient agents face borrowing limit (as in classic

Bewley-Ayiagary-Hugget)

• 3. Impatience motivates borrowing (not idiosyncratic shocks)

Results

• 1. If prices ‡exible ! redistribution neutral or contractionary
• 2. If prices sticky ! redistribution (largely) expansionary

I Address role of borrowing constraints, nominal rigidities,

persistence, govt. debt

Model: households

max E0 (

∞

∑

t=0

βt

j [u(cj,t) v(nj,t)]

) j = b, s βs |{z}

savers

> βb |{z}

borrowers

cj,t + rt1dj,t1 = dj,t + wtnj,t τj,t |{z}

lump-sum

+ σjPt |{z}

pro…ts share

db,t d | {z }

borrowing constraint

E¢ciency conditions

v

0(nj,t)

λj,t = wt

cons/leisure

λs,t = βsrtEt fλs,t+1g

Euler for savers

λb,t = βbrtEt fλb,t+1g + λb,t ψt |{z}

shadow value

• f

borrowing

Pseudo-Euler for borrowers

Notice

• 1. If borrowing constraint binding

ψt > 0 ! λb,t > λs,t | {z }

borrowers have higher shadow value of wealth

• 2. Credit premium

λb,t = βb

• rt

1 ψt

• Et fλb,t+1g

Firms

I Perfect competition

yt = F(nt) | {z }

production function

= F

∑

j

nj,t ! wt = F

0(nt) = 1

| {z }

if CRS

Government

∑

j

τj,t = g |{z}

…xed govt. spending

Neutrality

• 1. Perfect competition
• 2. Constant return to scale (CRS)
• 3. Steady state taxes are the same across agents
• 4. d = 0

cs,t + τs,t (rt1 1)d | {z }

zero

= F

0(nt)ns,t

cb,t + τb,t + (rt1 1)d | {z }

zero

= F

0(nt)nb,t

cs,tnϕ

s,t = F

0(nt)

cb,tnϕ

b,t = F

0(nt)

More generally

I d > 0 I DRS or monopolistic competition ! Equilibrium pro…ts

deviate from zero

I Natural assumption: savers hold shares of …rms

!Result: redistribution pro-borrowers is contractionary

2 4 6 8 10 12 14

• 0.2
• 0.15
• 0.1
• 0.05

Output

Redistribution from Savers to Borrowers: Flex Prices and Decreasing Returns

2 4 6 8 10 12 14

• 0.2
• 0.15
• 0.1
• 0.05

Aggregate Consumption

Intuition for contraction: asymmetry index

I Endowment economy ! Each agent receive yt/2 in every

period

I Resource constraint must imply!

b yt = cs y

• b

cs,t + cb y

• b

cb,t b cb,t = b yt (cb/y) cs cb

• | {z }

asymmetry index

b cs,t cs > cb | {z }

steady state

I If savers’ ss consumption larger

j∆b cb,tj > j∆b cs,tj j ∆b nb,t | {z } jborrowers’

l.supply falls

> j ∆b ns,t | {z } j savers’

l.supply rises I Asymmetric wealth e¤ect on labor supply

Nominal rigidities

I New Keynesian setup + heterogenous agents + borrowing

constraint

I Model inherently dynamic I Role of borrowing constraints in intertemporal substitution

Nominal rigidities

yt = Z 1

0 yt(i)(ε1)/εdi

ε/(ε1)

…nal good

yt(i) = nt(i) i 2 [0, 1]

• pf. di¤erentiated varieties

(1 + it) = rπφπ

t

monetary policy

Nominal rigidities

I Suppose prices …xed for two periods (t and t+1) ! Riskless

real int. rate constant

I Savers’ Euler equation implies

cs,t = cs,t1 = cs |{z}

savers’ consumption constant I Borrowers’ consumption not constant

r |{z}

constant riskless rate

βbEt cb,t cb,t+1

• = 1 ψt

| {z }

movements in credit premium

Nominal rigidities

yt = g + cs + cb,t |{z}

B.consumption drives

• aggr. output

Tax redistribution

∆τs,t = ∆τb,t > 0

I Transmission

# τb,t ! # ψt |{z}

credit premium

! " cb,t ! " yt |{z}

• utput

expansion

Labor market

I Aggregate labor supply

nt = ∑

j

nj,t = ∑

j

l

• cj,t, wt

pt

• L
• cb,t, cs, wt

p

• I Aggregate labor demand

nt = N wtµt p

Labor market

Aggregate labor market e¤ects of a pro-borrower tax redistribution under rigid prices.

Staggered prices

1 2 3 4 5 6 7 8 9 10 0.1 0.2 0.3 0.4 Output 1 2 3 4 5 6 7 8 9 10 0.1 0.2 0.3 0.4 Aggregate Consumption

Aggregate e¤ects of a pro-borrower tax redistribution: staggered prices.

5 10

• 1

1 2 Consumption 5 10

• 1

1 2 Hours 5 10

• 0.8
• 0.6
• 0.4
• 0.2

Finance Premium savers borrowers

Responses to a Tax Redistribution from Savers to Borrowers

5 10 0.1 0.2 0.3 0.4 Real Riskless Rate

Responses to a tax redistribution from the savers to the borrowers: sticky prices.

Temporary vs. Permanent Redistributions

0.1 0.2 0.3 0.4 0.5 0.6 0.7 0.8 0.9 1

• 0.5

0.5 1 1.5 2 2.5 3 3.5 4 4.5 Output Multiplier persistence in tax shock

Aggregate output impact multiplier of a tax redistribution that favors the borrowers.

Extensions

• 1. Endogenous borrowing limit
• 2. Government debt

Endogenous borrowing limit

db,t (1 χ)Et fwt+1nb,t+1g rt | {z }

can collateralize a fraction of future L. income

Government debt

Savers

• Fin. Intermediaries

Borrowers

• govt. bonds Bt

st= db,t+ ∆ (db,t) | {z }

intermed. frictions

db,t db

riskless deposits st

(1+i d

t )

(1+i t) = (1 + δt)

| {z }

spread

Debt-…nanced redistributions

gt + (1 + it1)Bt1 πt = Bt + ∑

j=s,b

τj,t

• govt. budget constraint

τj,t = (1 ρτ)τj + ρττj,t1 + φB

j Bt1

| {z }

reaction to

• govt. debt

+εj,t

Sharing the burden of debt stabilization φB

b = 0

φB

s > 0

• nly savers’ taxes adjust

φB

b > 0

φB

s > 0

both taxes adjust

Debt-…nanced redistribution

Flexible prices

2 4 6 8 10 12 14

• 0.01
• 0.005

0.005 0.01 0.015 0.02 Aggregate Output 2 4 6 8 10 12 14

• 0.01
• 0.005

0.005 0.01 0.015 0.02 Aggregate Consumption φ b = 0 φ b = 0.05 φ b = 0.1 φ b = 0.5

A tax cut to the borrowers under alternative values of φB

b : ‡exible prices.

Sticky prices

2 4 6 8 10 12 14

• 0.5

0.5 1 1.5 Aggregate Output 2 4 6 8 10 12 14

• 0.5

0.5 1 1.5 Aggregate Consumption φ b = 0 φ b = 0.05 φ b = 0.1 φ b = 0.5

A tax cut to the borrowers under alternative values of φB

b : sticky prices.