Abstract

This paper explores the effects of fiscal policy in an economy based on
indirect taxes, and one that is constrained to taxing all (labor and capital) income
at the same rate. The focus of the paper is on the relative importance of consumption
vs. income taxation, as well as on the provision of utility-enhancing public
services. To this end, a Real-Business-Cycle model, calibrated to Bulgarian data
(1999–2014), was set up with a richer public finance side. Bulgarian economy was
chosen as a case study due to its major dependence on consumption taxation as
a source of tax revenue. To illustrate the effects of fiscal policy, two regimes were
compared and contrasted to one another - exogenous vs. optimal (Ramsey) policy
case. The main findings from the computational experiments performed are: (i)
The optimal steady-state (capital and labor income) tax rate is zero, as it is the
most distortionary tax to use; (ii) The optimal steady-state consumption tax (the
only source of revenue) has to almost double to finance the optimally-set level of
government purchases