Fiscal policy and saving under distortionary taxation

An empirical investigation of the effects of fiscal policy on saving is carried out using Israeli data, which display large variability in both the saving rate and the fiscal variables. The framework is a small open economy model with distortionary taxation. The theoretical analysis of the partial effect of each fiscal variable on the national saving rate takes into account the necessary adjustment in future taxes. The present model predicts, for example, that the income-tax rate should have a negative effect on saving - in contrast to the Keynesian view - and that transfer payments and interest payments on the public debt should have positive effects - in contrast to the Ricardian view under lump-sum taxation. The empirical results partly support the predictions of the model - in particular for the income-tax rate. The methodology consists of two steps. First, quantitative predictions are obtained via simulation, and then the simulated effects are compared with the estimated coefficients.