Comments by John Hassler IIES, Stockholm University

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Comments byJohn HasslerIIES, Stockholm
University
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Sailing to Gotland
Västervik
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Sailing to Gotland
?
Västervik
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Prudent Navigation
Fårö
Västervik
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Prudent budget planning

• Does this apply to government budget planning?
• Most likely does uncertainty increase expected
  marginal cost of taxation.
• Concerns about future uncertainty should be
• Larger the higher expected future taxes are.
• Lower the better the financial position of the
  government is.
• Leads to recommendation of more positive expected
  surplus than otherwise and a build up of
  government financial assets. Very similar to the
  case of an individual who accumulates a buffer
  stock of savings.
• BUT
• This has nothing to do with deliberate
  underestimation of income, exaggeration of
  costs and pessimism.
• Perfectly in line with Barros smoothing of tax
  distortions, marginal cost of taxation today set
  equal to expected future marginal costs of
  taxation.

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Prudent budget planning - Costs of government
buffers

• Theoretical argument for debt debt is good since
  it can be used by households to build buffer
  stocks against idiosyncratic shocks.
• Probably not relevant for small open economy
  where individuals have acces to world capital
  markets.
• Surplus/deficits is one way to transfer taxation
  and spending over time. Considering long periods
  also between generations.
• How much how costly is it?
• Requires elaborate model and value judgments to
  answer.
• Here, some back-of-the-envelope calculations on
  the size of buffer stocks and intergenerational
  transfers.

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Simple numerical example

• First two things to note
• A reduction in surplus leads to less government
  assets in future requiring increasing taxes or
  falling spending,
• Government assets as a share of GPD will not
  explode if surplus is positive for ever. Long run
  expected debt is

• Intuition -- need a surplus to compensate for
  erosion by inflation and to keep up with growing
  GDP.
• Suppose also that expected inflation and growth
  both are 2 and the real bond yields is 1.
• Compare 0,1 and 2 targeted financial surplus.

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Net government assets
Share of GDP
0.5
0.4
0.3
0.2
Buffer stock slowly approaches 50 of GDP if
financial surplus is 2. Half of adjustment in
about 25 years.
0.1
0 surplus
0
20
40
60
80
100
Years from now
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Taxes with constant surplus
0.50
0.49
0.48
Initial difference in taxes/spendings of 2
erodes over time to 0.5.
0.47
0.46
0.45
0
20
40
60
80
100
x
Years from now
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Intergenerational transfers

• A 2 surplus leads to asset build-up and thus an
  expected transfer to future generations. How
  much?
• A simplistic example
• Suppose one generation is 30 years.
• Suppose the benefits of tax reduction would go to
  current old generation, paid by future ones.
• Over 30 years 2 surplus leads to a build up of
  assets ? 30 of GDP relative to case of zero
  surplus.
• This is about 1 of GDP during this period.

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Conclusion

• 2 surplus rather than 0 leads to net govt.
  assets of 50 of GDP.
• Awaiting more serious quantitative work, this dos
  not seem unreasonable from a prudent point of
  view.
• Rational prudence better than over-pessimism
  (more transparency and accountability)
• A little more than half is generated in one
  generation leading to a fairly small
  intergenerational transfer.
• Have not discussed
• Political failures is the money going to burn
  in the pockets of the politicians?
• Other reasons for larger intergenerational
  transfers.
• Portfolio choice, risk management, state
  dependent taxes.