178
BEYOND REFORMS
A possible arrangement could take the form of the revenue from the flexible tax being transferred—with full property rights—to the (autonomous) central bank (see annex, case 3).10 From an accounting perspective, such an arrangement would leave the actual fiscal balance unchanged, but a quasi-fiscal surplus would register at the central bank. The accounting identity of equation (6.9) would be modified in this way: 0 C S H Q,
(6.10)
where Q represents the extra revenue of the flexible tax—and a measure of the change in the quasi-fiscal surplus—as a proportion of GNP. By assumption, the government targets the structural fiscal surplus and overall excess expenditure (public and private). This means that the government should manage expenditures according to its structural revenues, and use the flexible tax rate to target a sustainable current account. The central bank, in turn, continues targeting inflation. The final outcome is relatively intuitive: an optimal equilibrium with zero inflation and no real variable misalignment. A flexible tax would still display various shortcomings difficult to tackle. Among other outcomes, the flexible tax should imply income effects only, with no distorting effects on resource allocation, a mix not trivial to attain. Also, the solution still has severe political economy problems. With the true problem being excess aggregate expenditure, the payers of the flexible tax would have a point when protesting their being designated to subsidize the system. The argument would be symmetrical to the one stressed by the beneficiaries of public programs when fiscal flexibility is attained through the expenditure side. From a different perspective, the efficacy of the flexible tax may be lessened, given its transitory nature, by Ricardian equivalence effects or by intertemporal tax planning—issues that our formal model does not tackle. Finally, when the flexible tax is in place, time-inconsistent behavior cannot be ruled out (for example, the authority might reduce the flexible tax in an election year).
A Tax on Financial Flows In cases where the main driving force of vulnerability is the presence of private deficits, a tax on the funding of those deficits would tackle the problem at its root.11 In terms of our model, such a tax would interfere in the arbitrage equation, affecting the cost of external funding. Case 4 of the annex describes the algebra of this situation, where we assume that the tax on financial flows generates no revenue (or it is reimbursed as a lump sum transfer to the private sector), so it acts as an efficiency tax rather than as a means of generating revenue.