Strategic Behavior, Debt Neutrality, and Crowding Out

Abstract

This paper presents an overlapping generations model in which children seek to manipulate the size of the end-of-life bequest they receive from the parent. I first use numerical simulations to show this intergenerational strategic behavior does not negate the debt neutrality assertions of Ricardian equivalence.Then, by introducing capital gains and inheritance taxes, I show the crowding out effect of government debt is notably smaller in models with strategic behavior; manipulation by children increases the importance of bequests, which forces parents to save (and bequeath) a larger portion of a debtfinanced tax cut. In spite of the neutrality of debt under lump sum taxes, including intergenerational strategic behavior can significantly influence the outcome of government tax policies.

Fiscal Deficits, Public Debt, and Sovereign Bond Yields

“…These results may not hold fully when assumptions about agents' behavior are modified (Rebelein, 2006). If agents are forward looking, there may be some "Ricardian equivalence" with private saving increasing, as fiscal deficits increase, in anticipation of future tax hikes to fulfill the intertemporal budget constraint.…”