Tax smoothing with immigration in an overlapping generations economy

ABSTRACT

Immigration policy in an overlapping generations economy is politically determined in response to government spending shocks, where the government finances its spending with proportional income taxes and is subject to a balanced budget. The young cohort is always the majority and dictates policy. The equilibrium Markovian strategy allows immigrants when the spending shock is above some threshold and this implies a particular form of tax smoothing.

KEYWORDS:

• Immigration
• tax smoothing
• overlapping generations
• political economy
• Markov perfect

JEL CLASSIFICATION:

• F22
• D72
• E61
• E62

Disclosure statement

No potential conflict of interest was reported by the author.

Supplemental data

A Supplemental appendix for this article can be accessed here

Notes

¹ The model yields identical results if there’s disutility from labor, as captured by Greenwood-Hercowitz-Huffman (1988) preferences. For simplicity I assume that young agents have a perfectly inelastic labor supply.

² I follow Bassetto (2008) in the assumption of proportional taxes in 2-period overlapping generations economy and also on the assumption that the tax rate applies to the principal and interest on capital. Unlike Bassetto’s model, I assume identical tax rates on capital and labor.

³ Immigrants can be given the right to vote in the second period, but this doesn’t change any of the insights since the assumption that agents have more than one child ($\eta >1)$ implies that the young generation is always the majority.

⁴ An alternative economic equilibrium concept that has received attention in the literature is the use of subgame perfection (of which Markov perfection is a refinement) with the use of trigger strategies. Papers employing such equilibrium concept include Cooley and Soares (1999), Boldrin and Rustichini (2000), Caucutt, Cooley, and Guner (2013) and Lopez-Velasco (2016).

⁵ This policy function implies that the current young generation assumes that the next generation plays strategy $x_{t+1}^{\ast }=1$ with probability $F\left(\bar{\gamma }\right)>0.$ The strategy $x_{t+1}^{\ast }={\left({\mu }_1{\gamma }_{t+1}\right)}^{\mu 2}$ which is continuous in ${\gamma }_{t+1}$ for all $\bar{\gamma }\le {\gamma }_{t+1}\le {\gamma }^{max}$ is played with probability density function $f\left({\gamma }_{t+1}|{\gamma }_{t+1}\ge \bar{\gamma }\right),$ given by $\frac{f\left({\gamma }_{t+1}\right)}{1-F\left(\bar{\gamma }\right)}$ with support in $\left[\bar{\gamma },{\gamma }^{max}\right]$.

Additional information

Funding

This research did not receive any grant from funding agencies in the public, commercial or not-for-profit sectors.