Fiscal Policy for Growth and Social Welfare
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horizontal equity dampens the redistributive effect of a progressive income tax (Lambert 2001). 15. In the classical version, the resulting optimal program is supposed to be implemented by a set of competitive and complete markets in view of the prevailing ownership of resources (Dixit 1996). 16. The latter is usually defined as 1 minus a measure of relative inequality (such as the Gini coefficient or the Atkinson index). 17. This is the bedrock concept in Atkinson’s 1970 framework for social evaluation of inequality (Atkinson 1970). When income is used as an indicator of well-being, the equally distributed equivalent income is the level of per capita income that, if enjoyed by every individual, would yield the same level of social welfare as the current distribution for some choice of utility of income. 18. Thus Kanbur (1995) explains that desirability is determined by welfare economics, whereas feasibility stems from political economy. 19. The transmission channels of public spending on growth are reviewed in detail in chapter 2. 20. The composition of productive public spending that is conducive to growth, taking into account both level and intrasectoral composition, must be determined at the individual country level. 21. Zagler and Dürnecker (2003) explain that a debt-financed tax cut could enhance economic growth due to reduced distortions relative to taxes. 22. This well-known “Barro hypothesis” is also supported by economists such as Vito Tanzi, who affirms that beyond 30 percent of the GDP, additional public spending usually leads to inefficiencies (Tanzi 2011). 23. Bernheim (1987) provides the following list of assumptions on which Ricardian equivalence rests, either explicitly or implicitly: (1) each generation is concerned with the well-being of its heirs and therefore leaves bequests; (2) capital markets function perfectly; (3) the timing of taxes has no redistributive effects within generations; (4) taxes are nondistortionary; (5) deficits cannot create value; (6) consumers are rational and forward looking; and (7) the political process is not affected by the availability of deficit financing as a fiscal instrument. 24. In the past, fiscal policy in developing countries has often been highly procyclical, with fiscal adjustment efforts occurring during economic downturns, often led by sharp cuts in public infrastructure spending. As Easterly, Irwin, and Servén (2007) argue, fiscal adjustment through infrastructure cuts can be like walking up the down escalator: the short-run effect is to raise cash flows, but the indirect effect is to reduce the supply of productive services, growth, and thus future tax bases. Over time, this effect may undo much of the short-term fiscal adjustment, requiring yet more spending cuts.