Fiscal Choices and Economic Outcomes
The Locke Institute series
Chapter 2: Models of Government
THE COMMON ECONOMIC AND FISCAL FUNCTIONS Those who control any government face a common pair of primary ﬁscal decisions: Choose the level of government expenditures and the rate of taxation that best serve their interests. For each type of government, thus, the control group must have a rough understanding of the eﬀects of these ﬁscal choices on the level of output and, in turn, on the level of tax revenues in the speciﬁc economy subject to that government. For each of the several major types of government, these eﬀects are represented by the following two common functions: Yϭa(1ϩG)b(1ϪR)c, and TϭRYϭa(1ϩG)bR(1ϪR)c, (2.2) (2.1) where Y is the level of output per potential worker, G is the level of government expenditures per potential worker (excluding military expenditures, net interest payments, transfer payments, and subsidies), R is the average tax rate (expressed as a share of output), and T is the level of tax revenues per potential worker.1 For these two functions, the parameter a is the level of output per potential worker that is independent of a government’s ﬁscal choices, the parameter b is the “elasticity” (relative proportionate change) of output with respect to the level of (1ϩG), and the parameter c is the elasticity of output with respect to the after-tax rate. Also, unless otherwise men6 Models of Government 7 tioned, the budget of each type of government is assumed to be...
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