Three Essays in Fiscal Policy

This thesis is a collection of three essays on fiscal policy. The two first essays discuss fiscal policy - in particular, tax progressivity - in quantitative models with heterogeneous agents. The last chapter describes optimal fiscal policy in an economy characterized by the presence of uncertainty.;The first essay, based on my joint work with Gaston Navarro, is primarily interested in government spending. This project is motivated by the following puzzle: empirical work suggests that government spending does not crowd out consumption, while most representative-agent models predict the opposite. In an environment with heterogeneous households and uninsurable idiosyncratic risk, I show that the progressivity of taxes is a key determinant of the effects of government spending. In particular, a rise in government spending can be expansionary, both for output and consumption, if financed with more progressive labor taxes. Finally, I use large changes in military spending to provide evidence that US government spending has been expansionary only in periods of increasing progressivity. In this respect, the distributional impact of fiscal policy is central to its aggregate effects.;The second essay focuses on sovereign risk, or to be more specific, on the interaction between incentives to default on sovereign debt and the distributional cost of taxes used to repay that debt. I extend the canonical Eaton-Gersovitz-Arellano model to include heterogeneous agents, progressive taxation, and elastic labor supply. When the progressivity of the tax schedule is exogenous, I show that progressivity and the incentive to default are inversely related. Less progressive taxes, and hence higher after-tax inequality, encourage default since the cost of raising tax revenue from a larger mass of low-income households outweighs the cost of default in the form of lost insurance opportunities. When tax progressivity is endogenous and chosen optimally, the government internalizes the influence of progressivity on default risk and the cost of borrowing. As such, I find that committing to a more progressive tax system emerges as an effective policy tool to reduce sovereign credit spreads in highly indebted countries.;The last essay, based on my joint work with Anastasios Karantounias, describes the optimal fiscal plan for taxes and government expenditures when government and households are ambiguous about the strength of the recovery. Indeed, historically high levels of public debt, together with a fragile economic recovery, have raised numerous concerns regarding fiscal policy. In particular, at what pace should governments do fiscal consolidation? Also, what is the optimal policy mix to reduce public debt: higher taxes, lower spending, or both? Under expected utility, fiscal policy is acyclical. When agents doubt the probability model of technology shocks, it becomes cyclical: it is procyclical when the intertemporal elasticity of substitution is smaller than unity, and counter-cyclical otherwise. This has striking long-run consequences: the optimal policy plan converges to a balanced budget in the first case, while it accumulates debt and delays taxes otherwise.