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Fiscal Austerity Measures: Spending Cuts vs. Tax Increases

Gerhard Glomm (), Juergen Jung () and Chung Tran

No 2013-01, Working Papers from Towson University, Department of Economics

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. (search for similar items in EconPapers)
JEL-codes: E21 E63 H55 J26 J45 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-dge, nep-fdg, nep-mac and nep-pbe
Date: 2013-01, Revised 2013-08
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http://webapps.towson.edu/cbe/economics/workingpapers/2013-01.pdf First version, 2013 (application/pdf)

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Working Paper: Fiscal Austerity Measures: Spending Cuts vs. Tax Increases (2012) Downloads
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