fiscal reform and government debt in japan: a …€¦ · · 2012-06-21fiscal reform and...

Fiscal Reform and Government Debt in Japan:A Neoclassical Perspective

Gary Hansen and Selo Imrohoroglu

UCLA Economics USC Marshall School

June 1, 2012

Gary Hansen and Selo Imrohoroglu (UCLA Economics USC Marshall School)Fiscal Policy and Debt 06/01/2012 1 / 33

Basic Issue

Japan faces two significant challenges

High debt to output ratioAging population

Projected Inreases in Government Expenditures

View issue through lens of neoclassical growth model.

How big is the problem and what are the consequences of possiblesolutions?


Two Significant challenges faced by Japan1. High Debt

1980 1985 1990 1995 2000 2005 20100.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

1

1.1Net Debt to GNP Ratio

Figure 1. Net Debt to GNP Ratio


Two Significant challenges faced by Japan2. Aging Population

2010 2020 2030 2040 2050 2060 2070 2080 2090 21000.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

Dependency Ratios

65+ to 216470+ to 2069

Figure 2. Dependency Ratios


Two Significant challenges faced by JapanImplications of the Aging Population: Fukawa and Sato (2009)

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

0.1

0.15

0.2

0.25Government Purchases to GNP Ratio

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 2080

0.1

0.15

0.2

0.25Transfer Payments to GNP Ratio

Figure 3. Government Expenditures toGNP Ratio


What We DoUse Hayashi and Prescott (2002)

1 Measure the size of fiscal adjustment needed2 Calculate the effects of two alternative fiscal policies designed toachieve fiscal balance


Methodology

Economic actors know the future, including futures changes ingovernment policy.

Exogenous: total factor productivity, tax rates, government spending,transfer payments, and population levels.

Actual values for 1981-2008, forecasts (Fukawa and Sato (2009)) after.

Model determines: Output, hours, investment, consumption, capitalstock, interest rates, and government debt.


More on What We Do

Implement a debt sustainability rule. Once an ad hoc threshold isreached, debt is reduced toward assumed long run level.

Compute required revenue to reduce debt given projected governmentexpenditures.

Compute two alternative fiscal policy transitions

Consumption taxLabor income tax


Why These Alternative Policies

The policies considered are not "optimal" policies. We are motivated bytwo considerations:

1 Politically there is likely an incentive to put off any reform as long aspossible. This is why we use a debt to output trigger.

2 We focus on consumption and labor income tax rates because of theirsimplicity. Further research should explore things like increasing theretirement age, other reforms of entitlement programs, encouragingimmigration, encourage female labor supply, etc.


Main Findings

Very large additional revenues needed to finance the projectedincreases in government expenditures due to aging

About 30% of aggregate consumption each year

If the government uses the consumption tax to finance the expectedburden due to aging, then the consumption tax rate needs to increasefrom its current level of 5% to about 35%.

If the labor income tax is used, then the tax rate will nearly doublefrom its current level of 30% to about 60%.

The welfare cost of using the labor income tax is 3.22% ofconsumption, which is more than twice that of using the consumptiontax to restore fiscal balance.


Model

Endogenous:

Hours worked (ht ), per capita consumption (Ct ), output (Yt ), thestock of capital (Kt+1), tax revenues, government debt (Bt+1), andthe price of government bonds, (qt ), from 1981 into the infinite future

Population: Nt+1 = ηtNt .

Exogenous:

Tax rates τh,t , τk ,t , τb,t , τc ,tGovernment purchases GtTransfer payments TRtWorking age population NtTFP At ,

Use actual time series 1981-2008; forecasts and assumptions for 2009and beyond.

Eventually, the tax rates, Gt/Yt ,TRt/Yt , growth rates of Nt and Atare all constant; economy converges to a balanced growth path.


Revenue Required to Stablilize DebtGovernment

Budget Constraint:

Gt + TRt + Bt = ηtqtBt+1 + τc ,tCt + τh,tWtht (1)

+τk ,t (rt − δ)Kt + τb,t (1− qt−1)Bt .

Debt Sustainability Rule:

Dt = κιt (Bt − B t ),

ιt =

{1 if Bs/Ys ≥ bmax for some s ≤ t,0 otherwise

Replace TRt with TR∗t = TRt −Dt


CalibrationTax Rates

Tax rate on Capital Income: Updated version of Hayashi and Prescott(2002)

Tax Rate on Labor Income: Updated version of Mendoza, Razin, andTesar(1994)

Tax Rate on Consumption:

0% 1981-19883% 1989-19965% 1997-2008

For 2009 and beyond, we assume that tax rates are constant at their2008 levels.


CalibrationTax Rates

1980 1985 1990 1995 2000 2005 20100

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

0.5Tax Rates

Consumption Tax RateLabor Income Tax RateCapital Income Tax Rate

Figure 4. Tax Rates


CalibrationTFP, Population Growth Rates, Expenditure Ratios

Actual Values used for 1981-2009Table 3. Calibration of TFP and Population Growth Rates

1981− 2009 2010− 2050 2051−∞γt Actual Values 1.02(1−θ) 1.02(1−θ)

ηt Actual Values Government Projections 1.0

Projections by Fukawa and Sato (2009)Table 4. Calibration of G/Y and TR/Y

1981− 2009 2010− 2050 2051−∞G/Y Actual Values linear increase from 0.198 to 0.238 0.238TR/Y Actual Values linear increase from 0.148 to 0.188 0.188


CalibrationTFP, Population Growth Rates, Expenditure Ratios

1980 2000 2020 2040 2060 208050

60

70

80

90WorkingAge Population

1980 2000 2020 2040 2060 2080100

150

200

250

300TFP (Normalized)

1980 2000 2020 2040 2060 2080

0.1

0.15

0.2

0.25Government Purchases to GNP Ratio

1980 2000 2020 2040 2060 2080

0.1

0.15

0.2

0.25Transfer Payments to GNP Ratio


CalibrationParameters for Fiscal Balance:

κ, bmax, and b

ιt =

{1 if Bs/Ys ≥ bmax for some s ≤ t,0 otherwise

Dt = κιt (Bt − B t ),

For the debt to output ratio along the balanced growth path, b, weuse a value of 60%.

For bmax, the debt to output ratio that triggers tax increases, we used150% and 200%.

For κ, see next slide.


CalibrationRevenue Requirements:

bmax = 150%

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

0.1

0.2

0.3

0.4

0.5

Consumption Tax Equivalent Revenue Requirement, (B/Y)m ax

= 1.5

κ = 0.15κ = 0.2κ = 0.25

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

0.5

1

1.5

2

2.5

3

Debt to GNP Ratio, (B /Y) m ax = 1.5

Figure 6. Revenue Requirement


CalibrationRevenue Requirements:

bmax = 200%

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

0.1

0.2

0.3

0.4

0.5

Consumption Tax Equivalent Revenue Requirement, (B/Y)m ax

= 2

1980 1990 2000 2010 2020 2030 2040 2050 2060 2070 20800

0.5

1

1.5

2

2.5

3

Debt to GNP Ratio, (B /Y) m ax = 2

κ = 0.1κ = 0.15κ = 0.2

Figure 7. Revenue Requirement


Quantitative FindingsBenchmark Results

1980 1985 1990 1995 2000 2005 20100.25

0.3

0.35

0.4Hours Worked

DataModel

1980 1985 1990 1995 2000 2005 20100.5

1

1.5x 10 6 Capital Stock

1980 1985 1990 1995 2000 2005 20102

3

4

5

6x 10 5 GNP

Figure 10. Capital, Labor and Output



1980 1985 1990 1995 2000 2005 20101.5

2

2.5

3

3.5x 10 5 Consumption

DataModel

1980 1985 1990 1995 2000 2005 20100.5

1

1.5x 10 5 Investment

1980 1985 1990 1995 2000 2005 20101.5

2

2.5

3Capital Output Ratio

Figure 11. Consumption, Investment, andCapital-Output Ratio



1980 1985 1990 1995 2000 2005 20100.92

0.94

0.96

0.98

1Bond Price

DataModel

1980 1985 1990 1995 2000 2005 20100

0.2

0.4

0.6

0.8

1Debt to Output Ratio

Figure 12. Bond Price and Debt to GNPRatio


Using a Distorting Tax Instead of Lumpsum Reduction inTransfersTransition Policy

Fiscal policy is assumed to follow

τx ,t =

τx ,2009 if Bs/Ys ≤ bmax for all s ≤ tτx + π if Bs/Ys > bmax for some s ≤ t and Bt/Yt > bτx if Bt/Yt ≤ b.


Using a Distorting Tax Instead of a Lumpsum TaxConsumption Tax

1980 2000 2020 2040 2060 2080 21000

0.05

0.1

0.15

0.2

0.25

0.3

0.35Consumption Tax Rate

Figure 13. Consumption Tax Rate


Using a Distorting Tax Instead of a Lumpsum TaxLabor Income Tax

1980 2000 2020 2040 2060 2080 2100 21200.2

0.25

0.3

0.35

0.4

0.45

0.5

0.55

0.6

0.65Labor Income Tax Rate

Figure 14. Labor Income Tax Rate


TransitionComparison

1980 2000 2020 2040 2060 2080 2100 21200.1

0.2

0.3

0.4

0.5Hours Worked

1980 2000 2020 2040 2060 2080 2100 21200

2

4

6x 10 6 Capital S tock

Lumpsum TaxConsumption TaxLabor Income Tax

1980 2000 2020 2040 2060 2080 2100 21200

1

2

3x 10 6 GNP

Figure 15. Labor, Capital, and Output


TransitionComparison

1980 2000 2020 2040 2060 2080 2100 21200

2

4

6

8

10

12x 10 5 Consumption


1980 2000 2020 2040 2060 2080 2100 21200

1

2

3

4

5

6x 10 5 Investment

Figure 16. Consumption and Investment


TransitionEffective Tax Rates

(1− τ) = (1− τh)/(1+ τc ) which implies τ = (τc + τh)/(1+ τh)

1980 2000 2020 2040 2060 2080 21000.2

0.25

0.3

0.35

0.4

0.45

0.5

0.55

0.6

0.65Effective Tax Rate

Labor Income Tax AdjustsConsumption Tax Adjusts


TransitionDebt to GNP

1980 2000 2020 2040 2060 2080 2100 21200

0.5

1

1.5

2

2.5

3Bond to GNP Ratio


Figure 17. Debt to GNP Ratios


TransitionOutput Effects

1980 2000 2020 2040 2060 2080 2100 21200.4

0.2

0

0.2

0.4

Out

put L

oss

Consumption TaxLabor Income Tax

Figure 18. Output Effects


Welfare Costs

What percentage decrease in consumption each period would givesomeone in the benchmark (lump sum tax) economy the same lifetimeutility as someone living in an economy where increases in theconsumption tax or labor tax is used to achieve fiscal stability?

λc = 1.41%

λh = 3.22%


ConclusionsThis Paper

Fiscal day of reckoning is soon—2017-2022.

A nearly PERMANENT increase in consumption tax rate of about 30percent.

A nearly PERMANENT increase in labor income tax rate of about 30percent.


Conclusions

Other possibilities:

social security reformimmigrationfertilityencourage female labor force participationreduce spending


fiscal reform and government debt in japan: a …€¦ · · 2012-06-21fiscal reform and...

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