Lack of Commitment, Retroactive Tax Changes, and Macroeconomic Instability

Salvador Ortigueira and Joana Pereira
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Joana Pereira: IMF

No WP2016-05, Working Papers from University of Miami, Department of Economics

Abstract: It is not uncommon that tax reform laws contain retroactive provisions. In this paper we are concerned with the fiscal and macroeconomic consequences of the constitutional ability of the government to retroactively revoke pre-announced income taxes. To this end, we study time-consistent optimal fiscal policy in a neoclassical economy where the government chooses the level of expenditure in a public good, debt issues and income taxation. When the government lacks commitment to these three fiscal variables, a complementarity between the decisions of the households and the government emerges, generating a multiplicity of expectations-driven equilibria. That is, fiscal policy is not uniquely pinned down by economic fundamentals, but it is determined by households' expectations about current and future policies. Accordingly, economies with identical fundamentals may display significantly different fiscal policies, consumption and investment.

Keywords: Retroactive Taxation; Expectation Traps; Equilibrium Multiplicity Publication Status: (search for similar items in EconPapers)
JEL-codes: E61 E62 H21 H63 (search for similar items in EconPapers)
Date: 2016
New Economics Papers: this item is included in nep-dge, nep-mac and nep-pbe
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Citations: View citations in EconPapers (1)

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