PROBLEMS AND APPLICATIONS

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Question 19.9

1. On April 1, 1996, Taco Bell, the fast-food chain, ran a full-page ad in the New York Times with this news: “In an effort to help the national debt, Taco Bell is pleased to announce that we have agreed to purchase the Liberty Bell, one of our country’s most historic treasures. It will now be called the Taco Liberty Bell and will still be accessible to the American public for viewing. We hope our move will prompt other corporations to take similar action to do their part to reduce the country’s debt.” Would such actions by U.S. corporations actually reduce the national debt as it is now measured? How would your answer change if the U.S. government adopted capital budgeting? Do you think these actions represent a true reduction in the government’s indebtedness? Do you think Taco Bell was serious about this plan? (Hint: Note the date.) Be sure to explain your answers.

Question 19.10

2. Draft a letter to the senator described in Section 19-3, explaining the logic of the Ricardian view of government debt and evaluating its practical relevance.

Question 19.11

3. The Social Security system levies a tax on workers and pays benefits to the elderly. Suppose that Congress increases both the tax and the benefits. For simplicity, assume that Congress announces that the increases will last for only one year.

  1. How do you suppose this change would affect the economy? (Hint: Think about the marginal propensities to consume of the young and the old.)

  2. Does your answer depend on whether generations are altruistically linked?

Question 19.12

4. Some economists have proposed the rule that the cyclically adjusted budget always be balanced. Compare this proposal to a strict balanced-budget rule. Which is preferable? What problems do you see with the rule requiring a balanced cyclically adjusted budget?

Question 19.13

5. Find some recent projections for the future path of the U.S. government debt as a percentage of GDP. What assumptions are made about government spending, taxes, and economic growth? Do you think these assumptions are reasonable? If the United States experiences a productivity slowdown, how will reality differ from this projection? (Hint: A good place to look is http://www.cbo.gov.)

1 To read more about how taxes affect the economy through incentives, the best place to start is an undergraduate textbook in public finance, such as Harvey Rosen and Ted Gayer, Public Finance, 10th ed. (New York: McGraw-Hill, 2014). In the more advanced literature that links public finance and macroeconomics, a classic reference is Christophe Chamley, “Optimal Taxation of Capital Income in a General Equilibrium Model With Infinite Lives,” Econometrica 54 (May 1986): 607–622. Chamley establishes conditions under which the tax system should not distort the incentive to save (that is, conditions under which consumption taxation is superior to income taxation). The robustness of this conclusion is investigated in Andrew Atkeson, V. V. Chari, and Patrick J. Kehoe, “Taxing Capital Income: A Bad Idea,” Federal Reserve Bank of Minneapolis Quarterly Review 23 (Summer 1999): 3–17.

2 For a survey of the debate over Ricardian equivalence, see Douglas Bernheim, “Ricardian Equivalence: An Evaluation of Theory and Evidence,” NBER Macroeconomics Annual (1987): 263–303. See also the symposium on budget deficits in the Spring 1989 issue of the Journal of Economic Perspectives.

3 Matthew D. Shapiro and Joel Slemrod, “Consumer Response to the Timing of Income: Evidence From a Change in Tax Withholding,” American Economic Review 85 (March 1995): 274–283.

4 Robert J. Barro, “Are Government Bonds Net Wealth?” Journal of Political Economy 81 (1974): 1095–1117.

5 B. Douglas Bernheim, Andrei Shleifer, and Lawrence H. Summers, “The Strategic Bequest Motive,” Journal of Political Economy 93 (1985): 1045–1076.

6 A recent literature on the fiscal theory of the price level reemphasizes the linkages between monetary and fiscal policy. For an introduction, see Christopher A. Sims, “Paper Money,” American Economic Review, April 2015, forthcoming.

7 To read more about indexed bonds, see John Y. Campbell and Robert J. Shiller, “A Scorecard for Indexed Government Debt,” NBER Macroeconomics Annual (1996): 155–197; and David W. Wilcox, “Policy Watch: The Introduction of Indexed Government Debt in the United States,” Journal of Economic Perspectives 12 (Winter 1998): 219–227.

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