Use of Fiscal Policy Reaction Functions in Analyzing the Macroeconomic Effects of Tax Policy

We model an empirically estimated fiscal policy reaction function (FPRF) in a macroeconomic growth model. In general, an FPRF uses information about the path of past and expected future macroeconomic events and fiscal policy to forecast future fiscal policy reactions. We show that an empirically estimated FPRF, consistent with past legislative activity, can return unsustainable fiscal forecasts to sustainability. However, we also demonstrate that modeling other variants of an FPRF, equally consistent with the literature, do not return fiscal forecasts to sustainability. We conclude that additional empirical work is necessary before implementation of an FPRF in macroeconomic models could decisively improve modeling results or their presentation.