Model Uncertainty and Intertemporal Tax Smoothing
University of Hong Kong
Federal Reserve Bank of Kansas City
Eric R. Young
University of Virginia
August 21, 2012
Federal Reserve Bank of Kansas City Working Paper No. 12-01
In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and the evolution of debt in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB improves the model’s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending, (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits in the US economy.
Number of Pages in PDF File: 46
Keywords: Robustness, Model Uncertainty, Taxation Smoothing, Taxation Tilting
JEL Classification: D83, E21, F41, G15working papers series
Date posted: April 20, 2012 ; Last revised: March 11, 2013
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