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Fiscal Foresight: Analytics and Econometrics

47 Pages Posted: 15 May 2008 Last revised: 20 Jun 2008

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

CAEPR

Multiple version iconThere are 2 versions of this paper

Date Written: May 12, 2008

Abstract

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 a non-invertible moving average component, which misaligns the agents' and the econometrician's information sets in estimated VARs. Economically meaningful shocks to taxes, therefore, cannot 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. Because non-invertibility arises as a natural outgrowth of the fact that agents' optimal decisions discount future tax obligations, it is likely to be endemic to the study of fiscal policy. In light of the implications of the analytical framework, we evaluate two existing empirical approaches to quantifying the impacts of fiscal foresight. The paper also offers a formal interpretation of the narrative approach to identifying fiscal policy.

Keywords: tax foresight, non-invertible moving average, VAR, Tax policy

JEL Classification: E6, H3

Suggested Citation

Leeper, Eric M. and Walker, Todd B. and Yang, Shu-Chun S., Fiscal Foresight: Analytics and Econometrics (May 12, 2008). CAEPR Working Paper No. 2008-013. Available at SSRN: https://ssrn.com/abstract=1132442 or http://dx.doi.org/10.2139/ssrn.1132442

Eric Michael Leeper (Contact Author)

Indiana University at Bloomington - Department of Economics ( email )

304 Wylie Hall
Bloomington, IN 47405-6620
United States
812-855-9157 (Phone)
812-855-3736 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
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Todd B. Walker

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

Shu-Chun S. Yang

CAEPR ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States

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