Three Essays on the Economics of Fiscal Externalities

Abstract

The three chapters of this dissertation investigate the effect of fiscal externalities on the welfare analysis of government social programs.

The first chapter introduces the subject of fiscal externalities, defined as the effects of a social program's labour market impacts on income tax revenues, and assesses their importance in the context of optimal unemployment insurance. I calibrate and simulate a dynamic job search model, and perform a theoretical and numerical analysis of Baily's (1978) two-period model of unemployment. The numerical results are significantly altered when fiscal externalities are taken into account: with moderate risk-aversion, the optimal replacement rate drops from around 40% to zero. However, higher risk-aversion moderates this effect, and a large positive effect of UI on wages could significantly increase the optimal benefit level.

In the second chapter, I evaluate the optimal tuition subsidy policy for post-secondary education while taking into account two of the most prominent justifications for government financial aid: liquidity constraints and fiscal externalities. I present a simple model and apply a sufficient statistics method to solve for an equation for the welfare gain from increasing aid. I then use statistical extrapolations and a calibration and simulation of my model to estimate optimal student grants. I find that financial aid should be more generous, and that the optimal amount of aid roughly corresponds to eliminating tuition at public universities. These results are largely unchanged if students face no liquidity constraints, whereas general equilibrium effects of tuition subsidies on wages can significantly affect the results.

In chapter 3, I add interactions between social programs to my study of fiscal externalities. I consider an example in which individuals can substitute between unemployment insurance and disability insurance, and demonstrate that the fiscal effects of substitution could significantly raise the optimal generosity of UI. I then present a general model which can be applied to any program of state-contingent transfers, and solve the model for a derivative of social welfare with respect to an individual program, with a simple and intuitive result that depends directly on the magnitude of fiscal externalities and program interaction effects.