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Laurence J. Kotlikoff

The combination of large budget deficits among industrial countries and exceptionally high short-term real interest rates has rekindled interest in crowding out and its potential effects on saving, capital formation, and financial variables. This paper describes how fiscal policies that result in economic deficits alter an economy’s saving behavior. Depending on the economy’s size and degree of openness, the changes in domestic savings arising from deficit financing can produce major changes in domestic investment, real interest rates, and real wage rates. Even if pretax returns to capital and labor are unaltered by deficits, because of international capital mobility and the equalizing of factor prices through trade, economic deficits can dramatically lower an economy’s long-run welfare. This paper provides a quantitative sense of how burdensome the “burden of the debt” may be.


This paper is a study of fiscal incentives for household saving. Section I discusses the rationale for and the general features of such incentives, and considers some of the problems that arise in their operation. A detailed consideration of different types of incentive, as applied in various countries, follows in Section II. Section III examines in depth the experience with these types of incentive in three countries—France, the Federal Republic of Germany, and Japan. Section IV contains some concluding remarks.


DEVELOPMENT POLICY has, until recently, been concerned primarily with stimulating economic growth. In light of the widely accepted view that economic growth was a precondition for a more equal distribution of income, little attention was given to the highly unequal income distribution that prevails in the less developed countries. These inequalities, however, are becoming less and less acceptable politically. Concern with the income distributional aspects of development policies has thus acquired new respectability. As Mr. Robert McNamara, President of the World Bank Group, stated at the Annual Meeting of the International Monetary Fund and the International Bank for Reconstruction and Development in 1972: “When the highly privileged are few and the desperately poor are many—and when the gap between them is worsening rather than improving—it is only a question of time before a decisive choice must be made between the political costs of reform and the political risks of rebellion” (McNamara, 1972, p. 26).1 He added that “shifts in the patterns of public expenditure represent one of the most effective techniques a government possesses to improve the conditions of the poor…. Governments can best begin … by initiating surveys on the effects of their current patterns of disbursement…. The Bank will assist in such surveys and, based on them, will help design programs, to be financed by it and others, which will improve the distribution of public services” (McNamara, 1972, p. 28).


The paper first addresses the question of the sustainability of debt growth by examining the behavior of taxation implied by fiscal rules that respect a government’s intertemporal budget constraint. Sustainable debt growth may require the tax burden to rise above some socially acceptable level. In this case, whereas drastic remedies may prove ineffective, a more relevant choice concerns the degree of monetary financing of the deficit (as distinct from monetization of the debt), which affects the dynamics of taxation implied by the constraint. Monetary financing is then introduced into a model by Blanchard, and the effects of monetary financing on the interest rate and capital intensity are examined. Finally, some policy implications are considered.

Mr. Vito Tanzi

Inflation affects individuals and income classes in many ways—as consumers, taxpayers, wage earners, savers, asset holders, lenders, borrowers, and so forth. Because of this multiplicity of influences, it is difficult, and perhaps impossible, to assess the total economic impact of inflation. For this reason, empirical studies have limited themselves to analyzing the impact of inflation on individuals or income classes in their roles as consumers, savers, or wage earners. This partial approach does not answer the question of whether the total impact of inflation is or is not beneficial to individuals in particular income classes, but it does provide interesting information that can be useful for policy purposes. This paper will follow this partial approach and analyze the impact of inflation on individuals in connection with the tax treatment of interest paid or received in the United States.

Evans Owen and LLoyd Kenward

On september 27, 1986, the U.S. Congress passed the Tax Reform Act, and on October 22 the President signed the Act into law. The Tax Reform Act of 1986 (TRA) made sweeping changes in the structure of the U.S. tax system, by curbing tax preferences and by using the room thus created to lower marginal tax rates. In this way, it was hoped, incentives to work, save, and invest would he enhanced, and economic performance would be improved. In addition, the elimination of many tax preferences was expected to help equalize the tax treatment of different investments, thus raising the efficiency of investment. The TRA was designed to be neutral in its overall effect on revenue over the period 1987-91, but it would significantly alter the distribution of the tax burden: the tax burden on corporations would increase by US$120 billion over the five-year period, whereas the personal tax burden would decline correspondingly. Receipts were increased substantially in fiscal year 1987 but are expected to be lower than otherwise in fiscal years 1989-91.


When there are collection lags in the tax system, inflation reduces real revenues. This is often offered as an argument for less reliance on the inflation tax. But the optimal rates of other taxes should also be reconsidered in the light of collection lags. When this is done, the focus shifts from the revenues (which can be recouped by changing the rates of these taxes) to the associated costs of collection. In a benchmark case where the average costs of collection are constant, the optimal inflation tax is independent of the collection lag.[JEL E51, E62, H21]

Edmund Phelps

The 1970s SAW the rise of a field of fiscal economics called optimum income taxation. Its subject is the properties of income tax structures, or tax tables, that are efficient, hence leaving no possibility for a general reduction of tax rates, except at a sacrifice of tax revenue, and no possibility for a reduction of the burden of taxation borne by one group, except at a cost to another. Thus far, research in this field has been confined to the taxation of personal income: wages, interest, and rent; the economics of business, or company, income taxation has been left untouched. In the now standard models of optimum income taxation there are no company profits and indeed no companies at all, incorporated or unincorporated; these models are extensions of the competitive general equilibrium model of neoclassical theory.

Mr. Vito Tanzi

The sensitivity (i.e., elasticity and built-in flexibility) of the U. S. individual income tax to changes in national income is of great interest to researchers and policymakers. However, the direct measurement of this sensitivity—that is, the measurement obtained from time-series observations of the relevant variables—has always been difficult, and even at times impossible, because changes in the legal structure of the tax have been too frequent to provide enough observations that relate to the same legal structure to allow statistically significant coefficients to be determined. This was particularly true in the United States before 1954, when the rates were changed frequently; it has also been true since 1963, when important changes occurred in rates, personal exemptions, deductions, and other features. In contrast, during the period between 1954 and 1963, hardly any significant statutory changes occurred in the tax.