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Federal Reserve Bank of Kansas City

By Yulei Luo, Jun Nie and Eric R. YoungYulei Luo and Eric R. Young


In this paper we examine how model uncertainty due to the preference for robustness (RB) affects optimal taxation and the evolution of debt in the Barro tax-smoothing model (1979). We first study how the government spending shocks are absorbed in the short run by varying taxes or through debt under RB. Furthermore, we show that introducing RB improves the model’s predictions by generating (i) the observed relative volatility of the changes in tax rates to government spending, (ii) the observed comovement between government deficits and spending, and (iii) more consistent behavior of government budget deficits in the US economy

Topics: Robustness, Model Uncertainty, Taxation Smoothing, Taxation Tilting. JEL Classification Numbers, D83, E21, F41, G15. We would like to thank Woong Yong Park for his detailed comments, Fred Kwan, Charles Leung, and Xiaodong
Year: 2012
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