A Dynamic Theory of Factor Taxation

Many important questions in macroeconomics concern the impact of taxation and spending policies on private resource allocation. One approach, typified by Robert Hall (1971) and William Brock and Stephen Turnovsky (1981), is to use dynamic general equilibrium models to address basic issues in fiscal and tax policy. The objective is to explicitly examine macroeconomic issues without embracing the market imperfections (fixed prices, missing markets, money illusion, etc.) found in conventional macroeconomic analysis. There is currently great interest in dynamic fiscal policy problems. This decade has already seen two major adjustments in tax policy, and many attempts to substantially alter spending patterns. The result of this tumult has been unprecedented peacetime deficits and much uncertainty about what measures will ultimately be used to bring the budget into balance. In this paper, I discuss the impact of alternative fiscal policies in a dynamic general equilibrium model. I examine the shortrun effects of fiscal policy changes, the efficiency cost of alternative dynamic tax policies, the effects of uncertain policy formation, and the redistributive effects of factor taxation.