How Does Limited Commitment Affect Government Spending and Taxation?

[sb717]

Hey can anyone provide any help with this economics problem? Thank you!

Suppose there is a credit market imperfection due to limited commitment. As in the limited
commitment model, each consumer has a component of wealth that has
value pH in the future period, cannot be sold in the current period, and can be pledged
as collateral against loans. Suppose that the government requires each consumer to pay a
lump-sum tax t in the current period, and a tax t0 in the future period. Also suppose that
there is limited commitment with respect to taxation as well. That is, if a consumer refuses
to pay his or her taxes, the government can seize the consumer's collateralizable wealth, but
cannot conscate income (the consumer's endowment). Assume that, if a consumer fails to
pay o his or her debts to private lenders, and also fails to pay taxes, the government has
to be paid rst from the consumer's collateralized wealth.

1. Show how the limited commitment problem puts a limit on how much the government
can spend in the current and future periods.
2. Write down the consumer's collateral constraint, taking into account the limited com-
mitment problem with respect to taxes.
3. Draw the consumer's lifetime budget constraint.
4. Suppose now that the government reduces t and increases t0 so that the government
budget constraint continues to hold. What will be the eects on an individual con-
sumer's consumption in the present and the future? Does Ricardian equivalence hold
in this economy? Explain why or why not.

Hint: It may be useful to see how the tax change aects a consumer that is
initially not aected by the collateral constraint and one who is separately.

 

[Evo]

Please repost this in the Other Scences section of the homework forums, and use the template, showing what you have done to answer this yourself. Thanks.