Working Paper: NBER ID: w14028
Authors: Eric M. Leeper; Todd B. Walker; Shuchun Susan Yang
Abstract: Fiscal foresight---the phenomenon that legislative and implementation lags ensure that private agents receive clear signals about the tax rates they face in the future---is intrinsic to the tax policy process. This paper develops an analytical framework to study the econometric implications of fiscal foresight. Simple theoretical examples show that foresight produces equilibrium time series with a non-invertible moving average component, which misaligns the agents' and the econometrician's information sets in estimated VARs. Economically meaningful shocks to taxes, therefore, cannot be extracted from statistical innovations in conventional ways. Econometric analyses that fail to align agents' and the econometrician's information sets can produce distorted inferences about the effects of tax policies. Because non-invertibility arises as a natural outgrowth of the fact that agents' optimal decisions discount future tax obligations, it is likely to be endemic to the study of fiscal policy. In light of the implications of the analytical framework, we evaluate two existing empirical approaches to quantifying the impacts of fiscal foresight. The paper also offers a formal interpretation of the narrative approach to identifying fiscal policy.
Keywords: Fiscal foresight; Econometrics; Tax policy; Identification strategies; VAR
JEL Codes: E6; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Fiscal foresight (H68) | Misalignment of information sets (D83) |
| Misalignment of information sets (D83) | Incorrect inferences about effects of tax policies (H31) |
| Fiscal foresight (H68) | Noninvertible VARMA representation (C32) |
| Noninvertible VARMA representation (C32) | Smaller information set of econometricians (C51) |
| Smaller information set of econometricians (C51) | Mislabeling of shocks (L15) |
| Misalignment of information sets (D83) | Erroneous conclusions regarding impact of anticipated tax changes on macroeconomic variables (H31) |
| Fiscal foresight (H68) | Challenges in econometric analysis of fiscal policy (E62) |
| Creative identification schemes (O36) | Failure to resolve challenges posed by fiscal foresight (H68) |
| Impulse response functions and variance decompositions (C22) | Misleading results without addressing fiscal foresight (H68) |
| Anticipated tax cuts (H29) | Little or no effect (contrary to evidence) (D91) |