. Fiscal Reform and Government Debt in Japan: A Neoclassical Perspective. May 10, 2013

Transcription

1 .. Fiscal Reform and Government Debt in Japan: A Neoclassical Perspective Gary Hansen (UCLA) and Selo İmrohoroğlu (USC) May 10, 2013

2 Table of Contents.1 Introduction.2 Model Economy.3 Calibration.4 Quantitative Experiments.5 Conclusion

3 Basic Issue Two significant challenges faced by Japan High debt to output ratio (close to 150%). Projected increase in government expenditures due to aging population. Spending to output projected to rise by 7% due to increases in pension and health spending. We explore size and consequences of fiscal responses to this problem.

4 High Debt Figure : Net Debt to GNP Ratio

5 Aging Population to to Figure : Dependency Ratios

6 Implications of Aging Population Fukawa and Sato (2009) 0.25 G/Y TR/Y Figure : Government Expenditures to GNP Ratios

7 What We Do Formulate and calibrate neoclassical growth model of Japan. Calculate effects of alternative fiscal policies designed to achieve fiscal balance. How large must tax rates on labor and/or consumption be to achieve this goal? First consider reducing transfers (lump taxes) and then consider distorting taxes.

8 What We Do Hayashi and Prescott (2002) and Chen, İmrohoroğlu and İmrohoroğlu (2006). Economic agents have perfect foresight. Characterize how model performs from Take as exogenous TFP, tax rates, government consumption, transfers and population. Use observed values Use model to forecast from 2011 and beyond. Government projections for population to Forecasts of Fukawa and Sato (2009) of G /Y and TR/Y to 2050.

9 Features of Model Government debt is introduced with bond price (interest rate) endogenous. Government bonds enter utility function rate of return dominance. Endogenous labor choice consumption and labor income taxes are distorting. Fiscal Sustainability Rule insures that intertemporal government budget constraint is satisfied.

10 Related Literature İmrohoroğlu and Sudo, Productivity and Fiscal Policy in Japan: Short Term Forecasts from the Standard Growth Model Experiment with policies to eliminate budget deficit in near future by increasing consumption tax. İmrohoroğlu and Sudo, Will a Growth Miracle Reduce Debt in Japan Assess possibility that high TFP growth could eliminate government debt.

11 Model: Government Budget G t + TRt + B t = η t q t B t+1 + τ c,t C t + τ h,t W t h t +τ k,t (r t δ)k t + τ b,t (1 q t 1 )B t. { 1 if Bs /Y ι t = s b max 0 otherwise for some s t, D t = κι t (B t B t ), TR t = TR t D t

12 Model: Household s Problem max subject to t=0 β t N t [log C t α h1+1/ψ t 1 + 1/ψ + ϕ log(µ t + B t+1 )] (1 + τ c,t )C t + η t K t+1 + q t η t B t+1 = (1 τ h,t )W t h t + [(1 + (1 τ k,t )(r t δ)] K t +[1 (1 q t 1 )τ b,t ]B t + TR t,

13 Model: Firm s Problem N t Y t = A t (N t K t ) θ (N t h t ) 1 θ N t+1 K t+1 = (1 δ)n t K t + N t X t A t+1 = γ t A t

14 Stationary Equilibrium Conditions Given a per capita variable Z t we obtain its detrended counterpart z t = Z t A 1/(1 θ) t First order conditions and market clearing conditions combine to give 10 equations in 10 unknowns {c t, x t, h t, y t, k t+1, b t+1, d t, q t, w t, r t } for each period t. Computation Objective: Find value for k 1 such that sequence converges to steady state..

15 Population and Labor Input N t = working age population between the ages of 20 and 69 Use actual values for Use official projections for Population constant after 2050 h t is employment per working age population multiplied by average weekly hours worked divided by 98 (discretionary hours available per week).

16 National Accounts: Hayashi and Prescott (2002) Table : Adjustments to National Account Measurements C = I = G = Y = Private Consumption Expenditures Private Gross Investment + Change in Inventories + Net Exports + Net Factor Payments from Abroad Government Final Consumption Expenditures + General Government Gross Capital Formation + Government Net Land Purchases Book Value Depreciation of Government Capital C + I + G

17 Government Accounts Public health expenditures in Japan are included in G t. TR t, includes social benefits (other than those in kind, which are in G t,) that are mostly public pensions, plus other current net transfers minus net indirect taxes. 8.1% of output is added to TR t since modeling of flat tax rates ignores deductions and exemptions.

18 Tax Rates τ h,t, are average marginal labor income tax rates estimated by Gunji and Miyazaki (2011). Last value is for 2007 and we assume that this remains constant thereafter. τ k,t, is constructed following methodology in Hayashi and Prescott (2002). Last value is for 2010 and we assume that this remains constant thereafter.

19 Tax Rates, continued Tax Rate on Consumption, τ c,t 0% % % % % 2015 and beyond. Tax Rate on Bond Interest, τ b, 20% for all time periods.

20 Tax Rates, continued Consumption Tax Rate Labor Income Tax Rate Capital Income Tax Rate Figure : Tax Rates

21 Technology Parameters A t = Y t /(K θ t h 1 θ t ). θ = 0.378, which is the average value from γ t = A t+1 /A t, comes from the actual data between 1981 and γ t = θ. for 2011 and beyond. δ = , which is the average value from

22 Preference Parameters Five preference parameters, β, α, ψ, ϕ, and µ. µ = µ t /A 1/(1 θ) t = 1.1. ψ = 0.5, the Frisch elasticity of labor supply estimated by Chetty et al (2012).

23 Preference Parameters, continued For β, α, and ϕ, use equilibrium conditions to obtain a value for each year, and then average over the sample: β t = (1 + τ c,t+1 )γ 1/(1 θ) t c t+1 (1 + τ c,t )c t [1 + (1 τ k,t+1 ) ( )] θ y t+1 k t+1 δ α t = h 1/ψ t (1 τ h,t )(1 θ)y t (1 + τ c,t )c t h t [ q t γ 1/(1 θ) ] t ϕ t = η t (µ + b t+1 ) β t [1 (1 q t )τ b,t+1 ]. (1 + τ c,t )c t (1 + τ c,t+1 )c t+1

24 Bond Price Need empirical counterpart to q t : q t = B t+1 /F t (B t+1 + P t+1 )/F t+1. B t is beginning of period debt. P t is interest payments made in period t. F t is the GNP deflator.

25 Bond Price, continued q from model q with φ = 0 q from data Figure : Bond Prices

26 Bond Price, continued Before Tax Rate of Return on Bonds Before Tax Rate of Return on Capital After Tax Rate of Return on Bonds After Tax Rate of Return on Capital Figure : Returns on Capital and Bonds

27 Structural Parameters Table : Calibration of Structural Parameters Parameter Value θ Data Average δ Data Average β FOC, α FOC, ψ 0.5 Chetty et al (2012) ϕ FOC, µ 1.1 fit q t for

28 Fiscal Sustainability d t = κι t (b t b y), { 1 if Bs /Y ι t = s b max for some s t, 0 otherwise b = 0.6 Consider b max = 200%, 250% and 300%. Japan already near 150%. Different value of κ for each b max.

29 Fiscal Sustainability Debt to GNP Ratio, b max = Consumption Tax Equivalent Revenue Requirement, b max = 2.5 κ = 0.05 κ = 0.1 κ = Figure : Revenue Requirement in the Benchmark Economy

30 Fiscal Sustainability 3.5 b max = 2.0, κ = 0.12 b = 2.5, κ = max b max = 3.0, κ = Figure : Bond to Output Ratio for Alternative Maximum Debt to GNP Ratios

31 Fiscal Sustainability 0.45 b = 2.0, κ = 0.12 max 0.4 b = 2.5, κ = 0.1 max b = 3.0, κ = max Figure : Revenue Requirement for Alternative Maximum Debt to GNP Ratios

32 Comparison of Benchmark with Data Hours Worked Data Model x 106 Capital Stock x 105 GNP Figure : Labor, Capital, and Output

33 Comparison of Benchmark with Data 3.5 x Consumption 105 Data 3 Model x 105 Investment Capital Output Ratio Figure : Consumption, Investment, and Capital-Output Ratio

34 Comparison of Benchmark with Data Figure : Bond to Output Ratio

35 Government Finance in Steady State Consumption Tax Revenue divided by benchmark output revenue/output G + TR divided by benchmark output consumption tax rate Figure : Consumption Tax Laffer Curve

36 Government Finance in Steady State Labor Tax G + TR divided by benchmark output 0.4 revenue/output Revenue divided by benchmark output labor income tax rate Figure : Labor Income Tax Laffer Curve

37 Tax Wedge From first order condition for labor, can define 1 τ t 1 τ h,t 1+τ c,t τ t = τ c,t+τ h,t 1+τ c,t

38 Government Finance in Steady State Combination of Taxes Effective tax rate 0.8 consumption tax rate Consumption tax rate labor income tax rate

39 Implementation of Tax Increases τ x,last if B s /Y s b max for all s t τ x,t = τ x + π if B s /Y s > b max for some s t and B t /Y t > b τ x if B t /Y t b. where x = c or h and t π is chosen as the smallest increment that leads to the activation of the second trigger (convergence to steady state).

40 Increase Consumption Tax Only 0.7 Consumption Tax Experiment consumption tax rate labor income tax rate Figure : Consumption Tax Experiment 1

41 Increase Both Consumption and Labor Tax Use Consumption Tax to Retire Debt, Increase Labor Tax to 45%. 0.7 Consumption Tax Experiment consumption tax rate 0.4 labor income tax rate Figure : Consumption Tax Experiment 2

42 Increase Both Consumption and Labor Tax Use Labor Tax to Retire Debt, Increase Consumption Tax to 40%. 0.7 Labor Income Tax Rate Experiment 0.6 labor income tax rate consumption tax rate Figure : Labor Income Tax Rate

43 Transition Paths for Various Experiments Labor Input x Capital Stock 106 lumpsum 2 tc1 tc2 th x 105 Output Figure : Labor, Capital, and Output

44 Transition Paths for Various Experiments 6 x 105 Consumption x Investment 105 lumpsum 2.5 tc1 tc2 2 th Figure : Consumption and Investment

45 Transition Paths for Various Experiments lumpsum tc1 tc2 th Figure : Debt to GNP Ratio

46 Effective Tax Distortion lumpsum tc1 tc2 th Figure : Effective Tax Rate

47 Conclusion Soaring debt to GNP ratio implies fiscal day of reckoning is soon around Costs of aging population require large nearly permanent increases in tax rates: Consumption tax: permanent increase to 48% with additional 12% during transition. Both consumption and labor tax: permanent increase to 40%, smaller additional increase during transition.

48 Conclusion Other options to explore: Broaden tax base: 8.1% of GNP potential. Social security and health insurance reform. Increase fertility and/or allow immigration. Encourage female labor force participation. Reduce spending.