| An overlapping generation (OG) model is utilized to compare the long- and short-run welfare implications of a debt-financed reduction in the interest income tax rate to those of a balanced-budget tax reduction. Agents are assumed to live for two periods and be bequest-constrained in the absence of government budget deficits. Given a small government, we prove the existence of temporary and long-run equilibria, and investigate the stability properties of the model under both the debt-financed and balanced-budget tax regimes. We find that the model is stable if the government balances its finances, but saddlepoint-stable otherwise. In our investigation of tax reductions, we find that while debt-financing leads to undesirable long-run consequences, it may appear desirable in the short-run. In a democratic society, this could lead to public policy that is fiscally irresponsible.;Finally, we utilize the general model to represent the United States by allowing agents to live 55 year economic lives, and parameterizing the economy in a way Similar to Auerbach and Kotlikoff. By examining the eigensystem of this model we find the projection method can be easily applied, and that simulations can be accomplished on modest computer hardware. We find that decreased intertemporal aggregation causes some earlier findings to be reversed, but we conclude that the tendency towards fiscal irresponsibility exists.;To allow for a more general treatment of the above problem, we extend the OG model to allow agents to live for N periods. We develop an efficient numerical simulation method, based on the eigensystem of a local linearization of this general model, called the projection method. We prove the equivalence of the projection method to the use of terminal conditions, and also extent the projection method to include convergent equilibrium paths. Using a 3-period OG model, we test the simulation technique and verify conclusions reached with the 2-period model. |
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