Essays on optimal fiscal policy

Asimakopoulos, Stylianos (2014) Essays on optimal fiscal policy. PhD thesis, University of Glasgow.

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This thesis examines the properties of optimal fiscal policy in the long-run and over the business cycle in general equilibrium models with agents that differ with respect to their skills and with production processes embodying capital-skill complementarity. To this end, the thesis is composed of four chapters which asses different aspects of optimal fiscal policy under various specifications incorporating labour skill and production differences as well as different assumptions regarding the policy instruments available to the government. The first two chapters focus on the long-run, while the last two concentrate on business cycle dynamics. The first and third chapters examine setups that allow households to differ with respect to their income and whose position in the labour market with respect to their skill is exogenously determined. In contrast, the second and fourth chapters consider setups where the labour force belongs to a single household, which guarantees consumption irrespective of skill level, and unskilled labour can endogenously acquire skills to become skilled.
Chapter 1 presents a detailed numerical analysis of the effects of optimal fiscal policy in an economy where the households are heterogeneous with respect to their labour and capital income. The production structure is characterised by a CES function allowing for capital, skilled and unskilled labour. In this setup, optimal fiscal policy in the long-run implies a non-zero and positive tax rate on capital income together with highly progressive labour income taxes. Moreover, the level of the optimal tax rate on capital income and the progressivity of labour income taxes are sensitive to the weight placed on the skilled agents in the objective function of the government.
Chapter 2 analyses optimal factor income taxation when there are different returns to skilled and unskilled workers, who belong to the same household, and to capital in structures and equipment, under capital-skill complementarity and endogenous skill acquisition. We find that when all factor inputs are taxed at separate rates, both capital income taxes are zero in the long-run, there is a subsidy to education and labour income taxes are progressive. The progressivity in labour income taxes is reduced if investment in education cannot be subsidised, whereas if the government can only impose a single labour income tax, the tax on income from capital equipment will be non-zero. These results remain valid even if the government is restricted to satisfy a given level of debt to output ratio, although with welfare losses. Finally, we show that the transitional dynamics of the fiscal instruments from the exogenous to optimal taxation are not affected by the restrictions to the fiscal policy menu.
Chapter 3 examines how income taxes are optimally distributed over the business cycle in a model with high, middle and low income households when the government is restricted to balance its budget in each period. The findings of an empirically relevant model indicate that under optimal fiscal policy the income tax rate of the high income households has the lowest volatility and the income tax rate of the low income households exhibits the lowest counter-cyclicality. If the fiscal policy menu also includes a consumption tax, the progressivity of the income tax rates is even higher and the results regarding the volatilities of the income taxes are overturned. We further find that the progressivity of the income tax rates is optimally increased after an output-enhancing shock.
Chapter 4 undertakes a normative investigation of the quantitative properties of optimal tax smoothing in a business cycle model with state contingent debt, capital-skill complementarity, endogenous skill formation and stochastic shocks to public consumption, as well as total factor and capital equipment productivity. We also examine the properties of optimal taxation under a restriction on the debt to output ratio. Our main finding is that, an empirically relevant restriction which does not allow the relative supply of skilled labour to adjust in response to aggregate shocks, significantly changes the cyclical properties of optimal labour taxes. This result remains valid even in the presence of a budget rule that restricts the debt to output ratio. We show that the key to understanding this result is that the government finds it optimal to adjust labour income tax rates to alter the average net returns to skilled and unskilled labour hours.

Item Type: Thesis (PhD)
Qualification Level: Doctoral
Additional Information: The financial support for my PhD studies from the Economic and Social Research Council (ESRC) and from the Scottish Institute for Research in Economics (SIRE) is gratefully acknowledged.
Keywords: optimal fiscal policy, skill premium, capital-skill complementarity
Subjects: H Social Sciences > HJ Public Finance
Colleges/Schools: College of Social Sciences > Adam Smith Business School > Economics
Supervisor's Name: Malley, Prof. James and Angelopoulos, Dr. Konstantinos
Date of Award: 2014
Depositing User: Dr Stylianos Asimakopoulos
Unique ID: glathesis:2014-5282
Copyright: Copyright of this thesis is held by the author.
Date Deposited: 14 Jul 2014 10:52
Last Modified: 04 Sep 2015 15:45

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