Joint Implications of Consumption and Tax Smoothing

In this paper, the joint hypotheses of consumption and tax smoothing are shown to imply that the present value of expected proportionate declines in government non-interest outlays is approximately equal to a log-linear function of the budget deficit and private dissaving. In this exact linear relation, the budget deficit signals declines in future government outlays, after controlling for prospective changes in the tax base. Private dissaving controls for such prospective changes since, under the joint hypotheses, the present value of expected proportionate rises in tax revenues are approximately equal to a log-linear function of private dissaving. Both exact linear relations are tested in a VAR framework on annual post-World War II U.S. data. We find considerable empirical support for the theory.