Vito Polito

Assessing the Fiscal Stance in the European Union and the United States, 1970–2011

The huge increases in debt-GDP ratios following the 2007–2009 global financial crisis, which are unprecedented except in times of war, has focused attention on the viability of the fiscal positions of EU countries and the US, how to assess this and the likely future evolution of these positions. This paper proposes an indicator of the fiscal stance which computes the fiscal adjustment required to reach a specific debt-GDP targeted given the forecasts of future deficit and interest rates obtained from an unrestricted (recursively-estimated) VAR model. The index is easy to compute and can be decomposed to disclose the different contribution of revenue, expenditure, nominal yields, inflation and growth to the fiscal stance. For this reason it provides a transparent and detailed measure of the fiscal stance, particularly suitable for multi-country surveillance. As a result, the index improves on the tax-gap indicators widely used by governments and international agencies, and is far more informative than formal econometric tests of fiscal sustainability. The time series of the indicator for individual EU countries and the US show that their fiscal position has fluctuated considerably over the last 40 years, and has particularly deteriorated since 2007. The index predicts that the adjustment required to restore pre-crisis debt-GDP levels are higher for high debt countries like Greece, Italy and Portugal. They become more severe the shorter is the time horizon for the adjustment. As a large degree of uncertainty surrounds the assessment of the fiscal stance in the medium and long run, we argue that policy makers should inform their policy based on the worst case scenario predicted by the indicator.

Unemployment, Crime and Social Insurance

We study an individuals incentive to search for a job in the presence of random criminal opportunities. These opportunities extenuate moral hazard, as the individual sometimes commits crime rather than searching. Even when he searches, he applies less effort. We then revisit the design of optimal unemployment insurance in this environment. If the individual is more likely to remain unemployed and unpunished when he commits crime than when he searches for a job (as suggested by empirical studies), declining unemployment benefits reduce the payoff from crime relative to that from searching. Compared to the canonical models of optimal unemployment insurance, this provides a further incentive to reduce benefits over time.

Up or Down? Capital Income Taxation in the United States and the United Kingdom

Empirical evidence suggests that the Effective Marginal Tax Rate (EMTR) on income from capital has increased considerably in both the United States and the United Kingdom over the period 1982-2005. This evidence contradicts the corporate tax literature which predicts that the EMTR should instead fall over time as a result of increasing international capital mobility and higher tax competition between governments. This paper argues that this inconsistency is entirely due to the fact that EMTRs on income from capital are currently computed from versions of the neoclassical investment model which do not take into account financial constraints on dividend policy faced by firms investing in both the United States and the United Kingdom. The paper incorporates financial constraints on dividend policy into the analytical framework for the computation of the EMTR and employs the new model to re-calculate time series of the EMTRs in both countries. The new empirical results show that, in contrast to the existing evidence, the EMTR on investment financed by either retained earnings or new equity has indeed declined over time in both countries, while the EMTR on debt-financed investment has remained relatively stable.