Managing government wealth in an aging society : The implications of fiscal rules

Abstract

This paper uses a large-scale overlapping generations model to assess the impact of fiscal rules in Norway. I apply up-to-date mortality and fertility rates, realistic projections for petroleum revenues and age profiles for government consumption. The calibration makes sure that the current Norwegian fiscal rule was satisfied in 2006, and the model is then used to study the economy's transition paths, starting in 2007, implied by the current and alternative fiscal rules. The current 4-percent rule is considered as the benchmark and I experiment with four alternatives: a growth-adjusted rule, a spending rule, constant tax rates and a wealth targeting rule. In all scenarios tax rates adjust to satisfy the fiscal constraint. Due to large petroleum resources, alternative fiscal rules give rise to large differences in the timing and level of taxes and the welfare of different generations.

In my stylized economy a continuation of the current fiscal rule gives rise to a short-term tax reduction and a long-term tax hike. Between 2006 and 2028 labor income taxes are reduced from 39 to 26 percent. From 2028 the tax rate is increased continually. The long run tax rate is 60 percent. These results are consistent with previous findings, e.g. Holmøy and Stensnes (2008).

Alternative rules create very different tax rate dynamics. In the growth-adjusted scenario, which represents a more conservative regime, labor income tax rates are at most 7 percentage points larger in the short term, and 25 percentage points smaller in the long-term. The lowest sustainable constant tax rate is 36 percent. In the spending scenario, tax rate is negative the first two years, and grows rapidly until it reaches 55 percent at the end of this century. Since alternative fiscal rules create different tax paths, they necessarily redistribute welfare among generations compared to the benchmark scenario. In the growth-adjusted scenario, generations currently alive and those born in early transition years lose. The loss is the equivalent of 2.5 percent of life-time resources for some cohorts. In terms of consumption and leisure, this represents a 2.5 percent decrease in all remaining years alive. Future generations gain considerably. Cohorts born in 2050 gain 2.5 percent while the long-run gain is 17 percent. In the spending scenario, current generations gain up to 6.4 percent, while future generations lose up to 7 percent.