Comments by John Hassler IIES, Stockholm University

1. Comments byJohn HasslerIIES, Stockholm University

2. Visby Sailing to Gotland Västervik

3. Fårö Sailing to Gotland ? Västervik

4. Prudent Navigation Fårö Västervik

5. Prudent budget planning • Does this apply to government budget planning? • Most likely does uncertainty increase expected marginal cost of taxation. • Concerns about future uncertainty should be; • Larger the higher expected future taxes are. • Lower the better the financial position of the government is. • Leads to recommendation of more positive expected surplus than otherwise and a build up of government financial assets. Very similar to the case of an individual who accumulates a buffer stock of savings. • BUT; • This has nothing to do with ”deliberate underestimation of income”, ”exaggeration of costs” and ”pessimism”. • Perfectly in line with Barro’s smoothing of tax distortions, marginal cost of taxation today set equal to expected future marginal costs of taxation.

6. Prudent budget planning - Costs of government buffers • Theoretical argument for debt; debt is good since it can be used by households to build buffer stocks against idiosyncratic shocks. • Probably not relevant for small open economy where individuals have acces to world capital markets. • Surplus/deficits is one way to transfer taxation and spending over time. Considering long periods also between generations. • How much – how costly is it? • Requires elaborate model and value judgments to answer. • Here, some back-of-the-envelope calculations on the size of buffer stocks and intergenerational transfers.

7. Simple numerical example • First two things to note: • A reduction in surplus leads to less government assets in future requiring increasing taxes or falling spending, • Government assets as a share of GPD will not explode if surplus is positive for ever. Long run expected debt is: • Intuition -- need a surplus to compensate for erosion by inflation and to keep up with growing GDP. • Suppose also that expected inflation and growth both are 2% and the real bond yields is 1%. • Compare 0,1 and 2% targeted financial surplus.

8. 2% surplus 1% surplus Net government assets Share of GDP 0.5 0.4 0.3 0.2 Buffer stock slowly approaches 50% of GDP if financial surplus is 2%. Half of adjustment in about 25 years. 0.1 0 surplus 0 20 40 60 80 100 Years from now

9. 2% surplus 1% surplus 0 surplus Taxes with constant surplus 0.50 0.49 0.48 Initial difference in taxes/spendings of 2% erodes over time to 0.5%. 0.47 0.46 0.45 0 20 40 60 80 100 x Years from now

10. Intergenerational transfers • A 2% surplus leads to asset build-up and thus an expected transfer to future generations. How much? • A simplistic example: • Suppose one generation is 30 years. • Suppose the benefits of tax reduction would go to current old generation, paid by future ones. • Over 30 years 2% surplus leads to a build up of assets  30% of GDP relative to case of zero surplus. • This is about 1% of GDP during this period.

11. Conclusion • 2% surplus rather than 0 leads to net govt. assets of 50% of GDP. • Awaiting more serious quantitative work, this dos not seem unreasonable from a prudent point of view. • Rational prudence better than over-pessimism (more transparency and accountability) • A little more than half is generated in one generation leading to a fairly small intergenerational transfer. • Have not discussed: • Political failures – is the money going to burn in the pockets of the politicians? • Other reasons for larger intergenerational transfers. • Portfolio choice, risk management, state dependent taxes.