Events at CERGE-EI

Prof. Christopher Phelan

University of Minnesota, United States

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Meeting number: 2740 877 3254
Meeting password: 683214

Abstract: This paper explores the effects of one nation’s subsidization of saving/taxation of consumption on the welfare of future generations of other countries. To do this, it presents an otherwise standard one-good two-country optimal growth model, but where each date represents the lifetime of a generation which cares not only about its own consumption and leisure, but also that of its descendants. It first derives conditions for, properly defined, Pareto efficiency. These conditions are shown to be exactly the same as if households lived forever, except the standard intertemporal condition holds as an inequality rather than as an equality. Next, it considers tax/subsidy schemes under an assumption of free international capital markets, and demonstrates that non-negative saving subsidies or weakly decreasing consumption taxes (with offsetting labor subsidies) by either or both countries induce Pareto efficient equilibria.
It then considers the welfare effects of one country using tax policy to induce lower consumption/higher savings in its initial generations. Relative to a benchmark where neither country ever taxes consumption or subsidizes savings, such a policy, for nearby generations, has ambiguous welfare effects for the citizens of the other country. Higher initial savings in the first country raises capital levels, and thus wages, in both countries, raising welfare of future generations in the second country, but also induces lower bequests in the second country, lowering the welfare of its future generations. In the long run, or for generations born near the steady state, the welfare effects of the first country inducing lower consumption/higher savings of its initial generations are unambiguous: future generations of the second country are made worse off. Given enough time, households born in the second country will regret that their ancestors allowed such policy-induced intertemporal trade.