Fiscal Austerity Measures: Spending Cuts vs. Tax Increases

44 Pages Posted: 10 Oct 2014

See all articles by Gerhard Glomm

Gerhard Glomm

Indiana University Bloomington - Department of Economics; CESifo (Center for Economic Studies and Ifo Institute)

Juergen Jung

Towson University - Department of Economics

Chung Tran

Australian National University (ANU) - School of Economics

Date Written: August 19, 2013

Abstract

We formulate an overlapping generations model with skill heterogeneity and productive and non-productive government programs to study the macroeconomic and intergenerational welfare effects caused by risk premium shocks and government debt reductions. We demonstrate that in a small open economy with a high level of debt-to-GDP ratio a small increase in the risk premium leads to substantial output contraction and negative welfare effects. Next, we quantify the effects of reducing the debt-to-GDP ratio using a wide range of fiscal austerity measures. These reforms result in trade-offs between short-run contractions and long-run expansions in aggregate output. In addition, the spending-based austerity reform is dominated by the tax-based reform in terms of income in the short run, but becomes dominant in the long run. The welfare effects vary significantly across generations, depending on fiscal austerity measures, skills and working sector. The current old and middle age generations experience welfare losses while current young workers and future generations are beneficiaries of the reforms. A mixed reform results in the largest welfare effects.

Keywords: fiscal consolidation, welfare, distributional effects, overlapping generations, dynamic general equilibrium

JEL Classification: E21, E63, H55, J26, J45

Suggested Citation

Glomm, Gerhard and Jung, Juergen and Tran, Chung, Fiscal Austerity Measures: Spending Cuts vs. Tax Increases (August 19, 2013). Available at SSRN: https://ssrn.com/abstract=2507283 or http://dx.doi.org/10.2139/ssrn.2507283

Gerhard Glomm

Indiana University Bloomington - Department of Economics ( email )

Wylie Hall
Bloomington, IN 47405-6620
United States
812-855-7256 (Phone)

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
Munich, DE-81679
Germany

Juergen Jung (Contact Author)

Towson University - Department of Economics ( email )

Baltimore, MD
United States
812-345-9182 (Phone)

HOME PAGE: http://https://juejung.github.io/

Chung Tran

Australian National University (ANU) - School of Economics ( email )

Arndt Building 25B
Canberra, Australian Capital Territory 0200
Australia

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