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.
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Notes
1 The model yields identical results if there’s disutility from labor, as captured by Greenwood-Hercowitz-Huffman (Citation1988) preferences. For simplicity I assume that young agents have a perfectly inelastic labor supply.
2 I follow Bassetto (Citation2008) 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 ( 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 (Citation1999), Boldrin and Rustichini (Citation2000), Caucutt, Cooley, and Guner (Citation2013) and Lopez-Velasco (Citation2016).
5 This policy function implies that the current young generation assumes that the next generation plays strategy with probability
The strategy
which is continuous in
for all
is played with probability density function
given by
with support in
.