• The Optimum Quantity of Debt for Japan
  Shuhei TakahashiTomoyuki Nakajima

  Abstract

  Japan's net government debt reached 130% of GDP in 2013. The present paper analyzes the welfare implications of the large debt for Japan. We use an Aiyagari (1994)-style heterogeneous-agent, incomplete-market model with idiosyncratic wage risk and endogenous labor supply. We find that under the utilitarian welfare measure, the optimal government debt for Japan is -50% of GDP and the current level of debt incurs the welfare cost that is 0.22% of consumption. Decomposing the welfare cost by the Flodén (2001) method reveals substantial welfare effects arising from changes in the level, inequality, and uncertainty. The level and inequality costs are 0.38% and 0.52% respectively, whereas the uncertainty benefit is 0.68%. Adjusting consumption taxes instead of the factor income taxes to balance the government budget substantially reduces the overall welfare cost.

  Introduction

  Japan's net government debt reached 130% of GDP in 2013 and the debt to GDP ratio is the highest among developed countries. A large number of papers, including Hoshi and Ito (2014), Imrohoroğlu, Kitao, and Yamada (2016), and Hansen and Imrohoroğlu (2016), analyze Japan's debt problem. However, the welfare effect of the large government debt has been less understood. Flodén (2001) finds that the optimal government debt for the United States is 150% of GDP. Is the optimal debt for Japan similar and hence should Japan accumulate more debt? Or does the current debt exceed the optimal level? How much is the welfare benefit of having the optimal level of debt instead of the current debt? 

  2017.03

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• The Effectiveness of Consumption Taxes and Transfers as Insurance against Idiosyncratic Risk
  Shuhei TakahashiTomoyuki Nakajima

  Abstract

  We quantitatively evaluate the effectiveness of a consumption tax and transfer program as insurance against idiosyncratic earnings risk. Our framework is a heterogeneousagent, incomplete-market model with idiosyncratic wage risk and indivisible labor. The model is calibrated to the U.S. economy. We find a weak insurance effect of the transfer program. Extending the transfer system from the current scale raises consumption uncertainty, which increases aggregate savings and reduces the interest rate. Furthermore, consumption inequality shows a small decrease.

  Introduction

  Households face substantial idiosyncratic labor income risk, and private insurance against such risk is far from perfect. The presence of uninsurable idiosyncratic earnings risk implies a potential role of government policies. The present paper examines the effectiveness of a consumption tax and transfer system as insurance against idiosyncratic earnings risk in an Aiyagari (1994)-style model with endogenous labor supply. We find that the transfer program is ineffective in terms of risk sharing. Expanding the current transfer scheme in the United States increases consumption volatility and precautionary savings. Thus, aggregate savings increase and the interest rate falls.

  2017.03

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• Consumption Taxes and Divisibility of Labor under Incomplete Markets
  Shuhei TakahashiTomoyuki Nakajima

  Abstract

  We analyze lump-sum transfers financed through consumption taxes in a heterogeneousagent model with uninsured idiosyncratic wage risk and endogenous labor supply. The model is calibrated to the U.S. economy. We find that consumption inequality and uncertainty decrease with transfers much more substantially under divisible than indivisible labor. Increasing transfers by raising the consumption tax rate from 5% to 35% decreases the consumption Gini by 0.04 under divisible labor, whereas it has almost no effect on the consumption Gini under indivisible labor. The divisibility of labor also affects the relationship among consumption-tax financed transfers, aggregate saving, and the wealth distribution.

  Introduction

  What is the effect of government transfers on inequality and risk sharing when households face labor income uncertainty? Previous studies, such as FlodÈn (2001) and Alonso-Ortiz and Rogerson (2010), find that increasing lump-sum transfers financed through labor and/or capital income taxes substantially decreases consumption inequality and uncertainty in a general equilibrium model with uninsured earnings risk. However, little is known about the impact of increasing consumption-tax financed transfers. Does it help people smooth consumption and does it reduce inequality? What is the impact on efficiency? The present paper analyzes these questions quantitatively.

  2016.03

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• Optimal taxation and debt with uninsurable risks to human capital accumulation
  Atsushi KajiiPiero GottardiTomoyuki Nakajima

  Abstract

  We consider an economy where individuals face uninsurable risks to their human capital accumulation, and analyze the optimal level of linear taxes on capital and labor income together with the optimal path of government debt. We show that in the presence of such risks it is beneficial to tax both labor and capital and to issue public debt. We also assess the quantitative importance of these findings, and show that the benefits of government debt and capital taxes both increase with the magnitude of idiosyncratic risks and the degree of relative risk aversion.

  Introduction

  Human capital is an important component of wealth both at the individual and aggregate level, and its role has been investigated in various fields in economics. In public finance, Jones, Manuelli and Rossi (1997) show that the zero-capital-tax result of Chamley (1986) and Judd (1985)1 can be strengthened if human capital accumulation is explicitly taken into account. Specifically, they demonstrate that, in a deterministic economy with human capital accumulation, in the long run not only capital but also labor income taxes should be zero, hence the government must accumulate wealth - that is, public debt be negative - to finance its expenditure.

  2015.03

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• Constrained Inefficiency and Optimal Taxation with Uninsurable Risks
  Atsushi KajiiPiero GottardiTomoyuki Nakajima

  Abstract

  When individuals’ labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks, the degree of heterogeneity among consumers’ income as well as on the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However in other cases a negative tax on capital is welfare improving. (JEL codes: D52, H21. Keywords: optimal linear taxes, incomplete markets, constrained efficiency)

  Introduction

  The main objective of this paper is to investigate the welfare effects of investment and labor income taxes in a two period production economy with uninsurable background risk. More precisely, we examine whether the introduction of linear, distortionary taxes or subsidies on labor income and/or on the returns from savings are welfare improving and what is then the optimal sign of such taxes. This amounts to studying the Ramsey problem in a general equilibrium set-up. We depart however from most of the literature on the subject for the fact that we consider an environment with no public expenditure, where there is no need to raise tax revenue. Nonetheless, optimal taxes are typically nonzero; even distortionary taxes can improve the allocation of risk in the face of incomplete markets. Then the question is which production factor should be taxed: we want to identify the economic properties which determine the signs of the optimal taxes on production factors.

  2015.02

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• A macroeconomic model of liquidity crises
  Keiichiro KobayashiTomoyuki Nakajima

  Abstract

  We develop a macroeconomic model in which liquidity plays an essential role in the production process, because firms have a commitment problem regarding factor payments. A liquidity crisis occurs when firms fail to obtain sufficient liquidity, and may be caused either by self-fulfilling beliefs or by fundamental shocks. Our model is consistent with the observation that the decline in output during the Great Recession is mostly attributable to the deterioration in the labor wedge, rather than in productivity. The government’s commitment to guarantee bank deposits reduces the possibility of a self-fulfilling crisis, but it increases that of a fundamental crisis.

  Introduction

  The Great Recession, that is, the global recession in the late 2000s, was the deepest economic downturn since the 1930s. Lucas and Stokey (2011), among others, argue that just as in the Great Depression, the recession was made severer by a liquidity crisis. A liquidity crisis is a sudden evaporation of the supply of liquidity that leads to a large drop in production and employment. In addition, the decline in output in the Great Recession was mostly due to deterioration in the labor wedge, rather than in productivity, as emphasized by Arellano, Bai, and Kehoe (2012).

  2014.03

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• Constrained Inefficiency and Optimal Taxation with Uninsurable Risks
  Atsushi KajiiPiero GottardiTomoyuki Nakajima

  Abstract

  When individuals’ labor and capital income are subject to uninsurable idiosyncratic risks, should capital and labor be taxed, and if so how? In a two period general equilibrium model with production, we derive a decomposition formula of the welfare effects of these taxes into insurance and distribution effects. This allows us to determine how the sign of the optimal taxes on capital and labor depend on the nature of the shocks, the degree of heterogeneity among consumers’ income as well as on the way in which the tax revenue is used to provide lump sum transfers to consumers. When shocks affect primarily labor income and heterogeneity is small, the optimal tax on capital is positive. However in other cases a negative tax on capital is welfare improving. (JEL codes: D52, H21. Keywords: optimal linear taxes, incomplete markets, constrained efficiency)

  Introduction

  The main objective of this paper is to investigate the effects and the optimal taxation of investment and labor income in a two period production economy with uninsurable background risk. More precisely, we examine whether the introduction of linear, distortionary taxes or subsidies on labor income and/or on the returns from savings are welfare improving and what is then the optimal sign of such taxes. This amounts to studying the Ramsey problem in a general equilibrium set-up. We depart however from most of the literature on the subject for the fact that we consider an environment with no public expenditure, where there is no need to raise tax revenue. Nonetheless, optimal taxes are typically nonzero; even distortionary taxes can improve the allocation of risk in the face of incomplete markets. Then the question is which production factor should be taxed: we want to identify the economic properties which determine the signs of the optimal taxes on production factors.

  2014.03

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