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A1248
Title: State capacity and pro-cyclical fiscal policy Authors:  Francesco Pappada - Banque de France (France) [presenting]
Yanos Zylberberg - University of Bristol (United Kingdom)
Abstract: Using data for 70 countries spanning 30 years, we show that, in countries with imperfect tax enforcement, the capacity to collect tax revenues is pro-cyclical and responds markedly to the level of taxes. We then incorporate this tax compliance channel into a standard model of sovereign debt in which a benevolent government can use fiscal policy or debt as consumption-smoothing instruments. While the first-best fiscal and debt policies should be counter-cyclical - e.g. deficit should increase in recessions through tax cuts - we show that, in the presence of a ``debt-ceiling'' constraint, they may be pro-cyclical. Consistent with the data, these pro-cyclical fiscal policies are much more likely to be observed in countries with low and very responsive tax compliance.