Taxation and Savings A Neoclassical Perspective

This paper discusses recent neoclassical analyses of taxation and savings. Contrary to the popular view that fiscal policy has highly ambiguous impacts on savings, neoclassical models admit a host of policies with clear and potentially quite powerful affects on the accumulation of wealth. The paper considers four fundamental types of fiscal policies and compares their quantitative affect on savings. The essential elements of these policies involve inter- and intragenerational redistribution, marginal and intra-marginal taxation, and the level of government consumption. Conventional accounting measures of "taxes", "spending", and "deficits" provide, at best, little guide to changes in underlying fiscal instruments and, at worst, precisely opposite indicators of the direction of such changes. Indeed, the continued use of and concern with conventional fiscal measures is symptomatic of wide spread fiscal illusion. These points are developed within the context of certainty models. The paper also considers the role of fiscal policy in both mitigating and exacerbating economic risks facing the private sector. Since precaution is a major motivation for saving, governments can greatly influence wealth accumulation either by using fiscal policy to pool private risks or by making fiscal policy itself highly uncertain