SLOW ADJUSTMENT AND THE LEVEL OF GOVERNMENT SPENDING

A distortionary tax finances a public service and, because of an adjus tment cost, the tax base adjusts slowly to any change in the tax rate. I compare the steady-state public service level with the level achiev ed using lump-sum taxation (first-best). Utility is assumed to be addi tively separable. If the government can commit, the public service is unaffected by the adjustment rare and is likely to be less than the fi rst-best level. However, if the government cannot commit, this outcome is time-inconsistent, If the government cannot, commit but reoptimize s continuously, the public service is affected by the adjustment rate. A very slow adjustment rate causes the marginal cost of funds to be a pproximately unity and the public service to strictly exceed the first -best level. (C) 1997 Academic Press.