Government

Table of contents

Each region has a government, responsible for tax spending and transfer decisions. A wide variety of taxes are modeled explicitly. Government spending on goods and services and labor is also modeled explicitly. Direct government transfers to households are also modeled explicitly.

These tax and spending decisions have budgetary consequences, being reflected in government deficits and so accumulated government debt. Interest payments on the stock of debt also impact on government deficits in each year.

Fiscal closures

It is important that there are no leakages from the tax and spending behaviour of the governments in each region. The difference needs to be reflected in the government deficit and the stock of government debt.

The appropriate representation of this system depends upon the variables that are made exogenous and those modeling decisions typically depend on the nature of the experiment being performed.

For example, G-Cubed can incorporate an endogenous budget deficit with lump-sum taxes on households adjusted gradually over time to cover any incremental interest payments to ensure fiscal sustainability. Thus, the level of government debt can permanently change in the long run with the change in debt to GDP equal to the ratio of the long-run fiscal deficit to the long-run real growth rate of the economy. Based on the extensive literature, including previous studies with the G-Cubed model, we know that the assumption of how carbon tax revenue is used can have significant macroeconomic implications. See McKibbin W. J., Morris, A., Wilcoxen P. J., and Y. Cai (2012) and McKibbin W. J., Morris, A., Wilcoxen P. J. and L. Liu (2017). In those studies the tax revenue is used to reduce the fiscal deficit across all regions.

The following approaches are available as alternative treatments that all provide ‘fiscal closure’. They are modules that should be turned on/off by appropriately commenting out all but the required module in the relevant ggg-configuration.sym or ggg-configuration.sym file. These files are located in the linear and the log subfolders of the model’s sym folder. Make changes to the appropriate configuration depending on the functional form being used.

These modules are provided as examples that are commonly useful. They do not preclude creation of new modules that achieve more specific control over various aspects of government behaviour.

Endogenous government deficit with exogenous projections for government spending at the sector/good level

Include the gggopt-fiscal-closure-deficit-endogenous-spending-endogenous.sym file in the SYM model definition to enable this module.

Use this module in experiments where you want to exogenously determine government spending on the goods produced by one or more sectors. All other aspects of government behaviour are endogenous and achieve fiscal closure.

The government deficit is defined as government spending and transfers and interest servicing costs, less total tax revenue.

The projections for GCE(good, region) are exogenous in this closure and they aggregate to a given total government spending excluding labor (GOVS) after allowing for changes in relative prices.

Endogenous government deficit and exogenous projections for total government spending (excluding labor)

Include the gggopt-fiscal-closure-deficit-endogenous-spending-exogenous.sym file in the SYM model definition to enable this module.

Use this module in experiments where you want to exogenously determine total government spending. A simple rule then allocates that spending across the goods produced by each sector. All other aspects of government behaviour are endogenous and achieve fiscal closure.

The government deficit is defined as government spending and transfers and interest servicing costs, less total tax revenue.

The projections for GOVS(region) are exogenous in this closure and they divide across the goods produced by the ordinary sectors in the economy, again responding to relative prices.

Exogenous government deficit and endogenous lump sum tax

Include the gggopt-fiscal-closure-deficit-exogenous-lump-sum-tax-endogenous.sym file in the SYM model definition to enable this module.

Use this module in experiments where you want to control the impact of government behaviour tightly, including total spending and deficits, with taxes adjusting accordingly.

Total government spending is determined endogenously, using the same approach as taken in the previous module.

The government deficit is the difference between the exogenously determined government spending and exogenously determined total taxes.

With the deficit also being exogenous, the residual is made up by a lump sum tax (that can be positive or negative) that adjusts to reflect the impact of all other government tax/transfer decisions and the impact of financing government debt.

Exogenous government deficit and endogenous government spending

Include the gggopt-fiscal-closure-deficit-exogenous-spending-endogenous.sym file in the SYM model definition to enable this module.

Use this module for experiments where the deficit is to be exogenous but instead of the consequences of tax and spending decisions showing up in a lump-sum tax, they flow through to government spending that is allocated across the various sectors according to a simple rule.

References

McKibbin, W. J., Morris, A. C., Wilcoxen, P. J. & Cai, Y. (2012), “The Potential Role of a Carbon Tax in US Fiscal Reform”, The Brookings Institution.

McKibbin, W. J., Morris, A., Wilcoxen P. J. & Liu, L. (2017), “The Role of Border Adjustments in a US Carbon Tax”, Climate Change Economics vol 9, no 1, 1-42.