Comparing Budget Repair Measures for a Small Open Economy with Growing Debt

46 Pages Posted: 15 Dec 2016

See all articles by George Kudrna

George Kudrna

University of New South Wales (UNSW)

Chung Tran

Australian National University (ANU) - School of Economics

Date Written: Novemeber 2016

Abstract

In this study, we quantify the macroeconomic and welfare effects of alternative fiscal consolidation plans in the context of a small open economy. Using a computable overlapping generations model tailored to the Australian economy, we examine immediate and gradual eliminations of the existing fiscal deficit with (i) temporary income tax hikes, (ii) temporary consumption tax hikes and (iii) temporary transfer payment cuts. The simulation results indicate that all three examined fiscal measures result in favourable long-run macroeconomic and welfare outcomes, but have adverse consequences in the short run that are particularly severe under the immediate fiscal consolidation plan. Moreover, our results show that cutting transfer payments leads to the worst welfare outcome for all generations currently alive, and especially the poor. Increasing the consumption tax rate results in smaller welfare losses, but compared to raising income taxes, the current poor households pay much larger welfare costs. Overall, the welfare trade-offs between current and future generations, as well as between the rich and poor, highlight key political constraints and point to challenging policy choices for the wellbeing of future generations.

Keywords: Fiscal Deficit, Public Debt, Fiscal Consolidation, Welfare, Dynamic General Equilibrium, Small Open Economy

JEL Classification: C68, E21, E63, H31, H60, J26

Suggested Citation

Kudrna, George and Tran, Chung, Comparing Budget Repair Measures for a Small Open Economy with Growing Debt (Novemeber 2016). CAMA Working Paper No. 73/2016 , Available at SSRN: https://ssrn.com/abstract=2885549 or http://dx.doi.org/10.2139/ssrn.2885549

George Kudrna (Contact Author)

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

Chung Tran

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

Arndt Building 25B
Canberra, Australian Capital Territory 0200
Australia

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