Tax Policy with Uncertain Future Costs: Some Simple Models (WP 13/07)

Abstract

This paper considers the extent to which the standard argument, that the disproportionate excess burden of taxation suggests the use of tax-smoothing in the face of future cost increases, is modified by uncertainty regarding the future. The role of uncertainty and risk aversion are examined using several highly simplified models involving a possible future contingency requiring an increase in tax-financed expenditure.

Acknowledgements

In preparing this paper we have benefited from discussions with Ross Guest and Omar Aziz. We are grateful to participants at a Long Term Fiscal Statement Panel Meeting, held at Victoria University ofWellington in September 2012, and Norman Gemmell, Hemant Passi, Michael Reddell and Paul Rodway for comments on an earlier version. In particular, we should like to thank Andrew Coleman for suggesting the use of the Epstein-Zin function.

Disclaimer

The views, opinions, findings, and conclusions or recommendations expressed in this Working Paper are strictly those of the authors. They do not necessarily reflect the views of the New Zealand Treasury or the New Zealand Government. The New Zealand Treasury and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained in these working papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate.