Fiscal Foresight and Information Flows
Eric M. Leeper
Indiana University at Bloomington - Department of Economics; National Bureau of Economic Research (NBER)
Todd B. Walker
Indiana University Bloomington - Department of Economics
Shu-Chun S. Yang
January 21, 2009
CAEPR Working Paper No. 2009-001
Fiscal foresight - the phenomenon that legislative and implementation lags ensure that private agents receive clear signals about the tax rates they face in the future - is intrinsic to the tax policy process. This paper develops an analytical framework to study the econometric implications of fiscal foresight. Simple theoretical examples show that foresight produces equilibrium time series with nonfundamental representations, which misalign the agents' and the econometrician's information sets. Economically meaningful shocks to taxes, therefore, cannot generally be extracted from statistical innovations in conventional ways. Econometric analyses that fail to align agents' and the econometrician's information sets can produce distorted inferences about the effects of tax policies. The paper documents the sensitivity of econometric inferences of tax effects to details about how tax information flows into the economy. We show that alternative assumptions about the information flows that give rise to fiscal foresight can reconcile the diverse empirical findings in the literature on anticipated tax changes.
Number of Pages in PDF File: 74
Keywords: taxes, foresight, nonfundamental
JEL Classification: E62, C50
Date posted: February 7, 2009
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