English publications

Economic theory points out that immigration of even low-skilled immigrants may improve public finances in Western welfare states, and it is some times suggested that fiscal sustainability problems in Western countries caused by ageing populations could be solved by increasing immigration. We examine consequences of various immigration scenarios using the large-scale computable general equilibrium model DREAM describing the Danish economy. It turns out that increased immigration will generally worsen the Danish fiscal sustainability problem. Improved economic integration of immigrants and their descendants, however, may alleviate the problems of the public sector considerably.

Based in generational accounts and a simple welfare calculus, this paper studies two alternative scenarios of sustainable fiscal policy in Denmark. A strategy of tax smoothing is found to provide a fairly even intergenerational distribution of the financial burden associated with population ageing. While tax smoothing causes a relatively sharp increase in public debt along the transition path, a strategy of debt smoothing is shown to pass a larger part of the financial burden onto current generations but without changing the intergenerational distribution profile in any dramatic way. A comparison based on a social welfare function indicates a marginal superiotity of tax smoothing.

An earned income tax credit is introduced in a dynamic CGE model with overlapping generations and imperfectly competitive labor market segments. The model is calibrated to a 10 percent sample of a register of all persons and workplaces in Denmark and scaled to the level of National Accounts. Each labor market segment is covered by a collective bargaining agreement, except one that is competitive. In all segments a distribution of workers with different productivity exists. A tax credit, which increases the net income of the poorest full.time employed workers in the economy by DKK 5000, reduces unemployment by 2.5 percentage points. Since the marginally employed have a productivity lower than the average worker, employment measured in productivity units increases only by approximately 1.5 percentage points. Women and younger generations tend to gain from the policy. The effect of the policy depends crucially on the initial level of unemployment because the productivity distributions are highly non-linear: if the initial level of unempolyment is halved to 5 percent so are the effects of unemployment and employment.

The structural effects of the Danish tax reform of 1993 are evaluated using DREAM, a dynamic CGE model of the Danish economy featuring overlapping generations of agents who have perfect foresight. The tax reform implied a reduction in the tax burden and the progressivity of the labor income taxation, an introduction of "green" taxes as revenue raising instrument and a restructuring of the capital income taxation. We find that the overall macroeconomic effects of the total reform are limited, but that the accumulation of wealth in the private sector is stimulated, which generates a long run increase in aggregate consumption. Analyzing the three parts of the reform separately reveals that the small net effect of the reform is due to counteracting forces of each of the parts. The reform is a strict Pareto improvement - given the initial calibration of the model - in the sense that all generations are better off after the reform.

To a large extent, Danish wage contracts are minimum wage contracts, where the wage of an employed worker consists of a negotiated minimum wage and a personal raise. This paper considers bargaining over minimum wages given that the members of the union have different levels of productivity. We show that the total wage of an individual in this case depends on both individual productivity and standard opportunity costs of the union. Further, it is shown that ceteris paribus the minimum wage is lower in this economy than the (total) wage in an economy where all workers have the same productivity. Finally, it is shown that increasing progressivity of the tax system does not necessarily imply a reduction in the minimum wage. A log-linearized version of the wage equation is estimated for 6 major unions using a panel which is a sub-sample of a representative 5 per cent sample of the Danish population. Estimated parameters of the marginal tax are negative for most male workers whereas this is not the case for women. Even for male workers the coefficients are much smaller than in previous studies based on macro data.

0. Contents
1. Preface
2. Introduction
2.1 A note on dating conventions
3. An Overview of the Model
3.1 Introduction
3.1.1 Producers
3.1.2 Households
3.1.3 The labour market
3.1.4 The government sector
3.1.5 International relations
3.1.6 Financial markets and equilibrium
3.1.7 Pension systems
3.2 DREAMs base-line projection
3.2.1 Population
3.2.2 Aggregate macroeconomic development
3.2.3 Composition of GDP
3.2.4 Prices
3.2.5 Government finances
3.2.6 National wealth

4. Producers behavior
4.1 The value of the firm
4.2 The problem of the private firm
4.2.1 Production function and nest structure of the firm
4.2.2 Investment and capital stock
4.2.3 Demand faced by the firm
4.3 Solving the problem of the private firms
4.3.1 Intertemporal optimization
4.3.2 Intertemporal optimization
4.4 Symmetric equilibrium
4.5 Aggregation across firms
4.5.1 Intertemporal optimization
4.5.2 Intertemporal optimization
4.6 Government production
4.6.1 Solving the problem of step 1
4.6.2 The output price of the government sector
4.7 Appendix: Equations describing private and government production i growth- and inflation-corrected terms
4.8 Appendix: Production technology

5. Households
5.1 Overview
5.2 Construction and assumptions
5.3 Preferences
5.3.1 Period utility
5.3.2 CES subutility
5.3.3 Lifetime utility for planning households
5.3.4 Bequest motive
5.4 Income and budget
5.4.1 Non-capital income
5.4.2 Capital income and asset accumulation
5.5 Consumption and saving
5.5.1 Consolidated budget
5.5.2 The Keynes-Ramsey rule
5.5.3 The bequest decision
5.6 Labour supply
5.6.1 Union model
5.7 Non-planning households
5.8 Consumption split
5.9 Appendix: Equations describing household behaviour in growth- and inflation-corrected terms

6. Pensions
6.1 The budget conditions of the pension fund
6.1.1 Retirement pensions
6.1.2 Spouse pensions
6.1.3 Disablement pensions
6.2 Forecasting, pension undertakings and principles af precaution
6.2.1 Actuarial constants
6.2.2 Pension undertakings
6.2.3 Principles of precaution
6.3 Derivation of individual pensions and premiums
6.3.1 Spouse pensions
6.3.2 Disablement pensions
6.3.3 Pension undertakings
6.3.4 Retirement pensions
6.4 The bonus
6.4.1 Overview of required assets
6.5 Evolution of pensions
6.6 Average pensions
6.6.1 Non-retired members
6.6.2 Retired members
6.6.3 Disabled members
6.6.4 Spouse pensioners
6.6.5 Member stocks

7. The government sector
7.1 Government revenue
7.1.1 Gross operating surplus
7.1.2 Land rent
7.1.3 Withdrawals from quasi corporations
7.1.4 Indirect taxes
7.1.5 Source taxes
7.1.6 Other revenue sources
7.2 Government expenditure
7.2.1 Government consumption
7.2.2 Investment expenditure
7.2.3 Subsidies
7.2.4 Transfers
7.3 The primary budget and government debt
7.4 Projection of government sector variables
7.4.1 Special indexation equations used in conection with the Danish tax freeze
7.4.2 Indexation of government consumption
7.4.3 Indexation according to wage regulation
7.4.4 Indexation of current and capital trandfers following GDP
7.4.5 Lump-sum transfers resulting from the calibration process
7.5 Sustainability of fiscal policy
7.6 Appendix: Equations describing government sector in growth- and inflation-corrected terms
7.6.1 Government revenue
7.6.2 Government expenditure
7.6.3 The primary budget and government debt
7.6.4 Projection of government sector variables

8. Miccellaneous
8.1 The foreign sector
8.2 Equilibrium conditions
8.3 National account measures
8.4 Financial assets
8.5 Steady state
8.6 Appendix: Equations describing miscellaneous behaviour in growht- and inflation-corrected terms

9. Data sources and calibration
9.1 Technique of calibration process
9.1.1 Static calibration
9.1.2 Dynamic calibration
9.1.3 Dynamic calibration and the base-line scenario
9.2 Procedure and results
9.2.1 Population
9.2.2 Labour market
9.2.3 Capital stocks and depreciation rates
9.2.4 Production
9.2.5 Final demand
9.2.6 Government finances
9.2.7 Growth, inflation, interest rates and the risk premium og shares
9.2.8 Labour-market pension funds, private pensions, ATP, SP and LD funds
9.2.9 Household wealth and saving
9.2.10 Foreign assets

10. Dynamic effects of policy experiments and exogenous shocks
10.1 Effects of a permanent rise in the (real) interest rate
10.2 Effects of a permanent rise in inflation and nominal interest rate
10.3 Effects of a permanent rise in productivity growth
10.4 Effects of a rise in the risk premium
10.5 Effects of a permanent decline in mark-ups
10.6 Effects of a permanent fall in the structural unemployment rate
10.7 A rise in the bottom-bracket tax rate
10.8 A rise in the VAT rates
10.9 A corporation tax hike
10.10 A rise in land taxation
10.11 A rise in the tax on owner-occupied dwellings
10.12 A change in the tax on interest income
10.13 A rise in the tax on pension funds income
10.14 A rise in the tax on resource revenue from yhe North Sea
10.15 A 5-year extension og the tax freeze

The Scandinavian welfare states are mature in the sense of having a high level of standards for public provisions of welfare services as well as a high replacement level for income transfers, especially for low income groups. In this welfare model, individuals have basic rights to welfare services and social transfers independently of their ability to pay, their labour market history etc. The financial viability of the model relies on a high tax burden and a high level of labour force participation for males and females. Evaluated on the basis of international comparisons of income levels and inequality, the model has performed well. In a forward looking perspective, however, the welfare model faces problems that may bring the financial viability of the model at stake. Two important challenges are demographic changes and the so-called growth dilemma (increased demand for services and leisure). We discuss these issues using Denmark as an example and argue that while these two challenges may be of the same order of magnitude, it is easier to propose solutions to the demographic challenges than to the growth dilemma which are consistent with the basic principles of the welfare state.

Conventional generational accounts are insufficient as instruments to judge the appropriateness of policies which may change intergenerational distribution. One of the reasons is that they are forward-looking and hence do not measure the impact of historical events. We construct a measure of full lifetime incomes and net government contributions for all generations born in Denmark from 1930 to 2030, combining historical figures with future projections on the large computable general equilibrium model DREAM. Despite many short-term fluctuations, the resulting development in lifetime income figures is relatively smooth, and net government contributions make up only a modest part of each generation’s consumption possibilities, even though present and expected future tax rates in Denmark make up no less than half of GDP.

This paper presents a quantification of the economic impacts to Denmark of the European Unions’ upcoming East enlargement. Specifically the effects of customs liberalization, market integration and immigration are quantified with due regard to estimated repercussions to transfers to and from the European Union and enhanced growth in the new member states. In the basecase projection, which excludes additional immigration, a steady state increase of aggregate GDP at factor costs of 0.08 percent is found along with a welfare gain of 1.27 percent of 1998 GDP. The welfare gains are demonstrated to be highly dependent on the catching up of the CEE region and the route taken by the EU for funding the enlargement.

In a world where labor earnings are uncertain and borrowing-constraints are present, progressive taxation is likely to have risk mitigating benefits for consumption-smoothing agents; higher tax payments are due in periods of life when income is relatively high, and less tax must be paid when income is low. This lowers the probability that the borrowing constraint becomes binding. The question is if this income-smoothing risk-mitigating property of progressive taxation has any value to the consumers? Simulations using a large-scale computable general equilibrium model with competitive markets show that consumers prefer progressive taxation of labor earnings to proportional taxation - a result that is contrary to the findings in the deterministic framework by Auerbach and Kotlikoff (1987). However, there is a trade-off between the positive risk-migating properties of progression, and the negative distortionary effects; indeed it turns out that there is an optimal level of progressivity.

This paper examines the consequences of introducing an idiosyncratic uncertain interest rate in a standard life-cycle model à la Auerbach and Kotlikoff (1987). Since the labor market has no uncertainty, labor earnings are used by the consumers to compensate for the risks in the capital market. The multi-period general equilibrium model introduces the possibility for consumers to adjust their labor supply ex post in response to new information becoming available (in addition to the opportunity to hedge ex ante). Increased uncertainty causes the number of hours worked to increase, since some old agents start supplying labor to compensate the poor performance of their savings. The framework also makes it possible to quantify the value of labor supply flexibility for these old agents.

This paper investigates the importance of the usual assumption of divisibility. In the labor market a finite set of choices is introduced: between working full or part-time or not to work at all. To add realism and to ensure smooth aggregate behavior the option of limited overtime for individuals working full time is introduced. The simulations show that indeed indivisibilities matter - the results obtained in each of the two models are markedly different. The impact of the policy experiment (a move from progressive to proportional taxation of labor income) is much larger in the case where the labor supply is continuous; the welfare gains of the switch from progressive to proportional taxation is almost 150 percent larger with continuous labor supply. The sensitivity analysis shows that this result depends on how the indivisibilities are specified, but in almost all cases are the welfare gains from the tax reform more than twice as large in the continuous model.

Recently David Laibson and others have argued in favor of using hyperbolic discount functions. The purpose of this paper is to investigate whether conventional wisdom, based on the standard model with exponential discounting, also holds in the case where consumers have hyperbolic discount functions. In other words do hyper-bolic preferences matter for practical policy evaluation? Within the framework of a suitably modified standard General Equilibrium model à la Auerbach and Kotlikoff, this is done by simulations of both fundamental changes in the tax base, as well as more marginal experiments comparing the excess burden of taxation. Based on the simulations it turns out that the answer to the question is a maybe: if preferences are sufficiently hyperbolic then policy conclusions change. Unfortunately this degree of hyperbolicness in the discounting function is at the level that is considered realistic by empirical studies.

Based on generational accounts and a simple welfare calculus, this paper studies two alternative scenarios of sustainable fiscal policy. A strategy of tax smoothing is found to successfully distribute the financial burden associated with population ageing across generations, but this happens at the cost of a sharp increase in public debt along the transition path. This can be avoided if a strategy of debt smoothing is followed, but this shifts the financial burden onto current generations. A comparison based on a social welfare function indicates a marginal superiority of tax smoothing.

An earned income tax credit is introduced in a dynamic CGE model with overlapping generations and imperfectly competitive labor market segments. The model is calibrated to a 10 percent sample of a register of all persons and workplaces in Denmark and scaled to the level of National Accounts. Each labor market segment is covered by a collective bargaining agreement, except one that is competitive. In all segments a distribution of workers with different productivity exists. A tax credit, which increases the net income of the poorest full.time employed workers in the economy by DKK 5000, reduces unemployment by 2.5 percentage points. Since the marginally employed have a productivity lower than the average worker, employment measured in productivity units increases only by approximately 1.5 percentage points. Women and younger generations tend to gain from the policy. The effect of the policy depends crucially on the initial level of unemployment because the productivity distributions are highly non-linear: if the initial level of unempolyment is halved to 5 percent so are the effects of unemployment and employment.

The structural effects of the Danish tax reform of 1993 are evaluated using DREAM, a dynamic CGE model of the Danish economy featuring overlapping generations of agents who have perfect foresight. The tax reform implied a reduction in the tax burden and the progressivity of the labor income taxation, an introduction of "green" taxes as revenue raising instrument and a restructuring of the capital income taxation. We find that the overall macroeconomic effects of the total reform are limited, but that the accumulation of wealth in the private sector is stimulated, which generates a long run increase in aggregate consumption. Analyzing the three parts of the reform separately reveals that the small net effect of the reform is due to counteracting forces of each of the parts. The reform is a strict Pareto improvement - given the initial calibration of the model - in the sense that all generations are better off after the reform.

To a large extent, Danish wage contracts are minimum wage contracts, where the wage of an employed worker consists of a negotiated minimum wage and a personal raise. This paper considers bargaining over minimum wages given that the members of the union have different levels of productivity. We show that the total wage of an individual in this case depends on both individual productivity and standard opportunity costs of the union. Further, it is shown that ceteris paribus the minimum wage is lower in this economy than the (total) wage in an economy where all workers have the same productivity. Finally, it is shown that increasing progressivity of the tax system does not necessarily imply a reduction in the minimum wage. A log-linearized version of the wage equation is estimated for 6 major unions using a panel which is a sub-sample of a representative 5 per cent sample of the Danish population. Estimated parameters of the marginal tax are negative for most male workers whereas this is not the case for women. Even for male workers the coefficients are much smaller than in previous studies based on macro data.

This paper gives an introduction to the Computable General Equilibrium (CGE) modelling, and presents an application of the technique to the analysis of the Europe Agreements between the EU and Hungary, Poland and the former Czechoslovakia. The main purpose of the paper is to illustrate the method, rather than present a state-of-the-art analysis. The CGE-approach makes it possible to pursue the analysis further than possible with analytical methods, and it can yield qualitative as well as quantitative results. A model is presented, and it is used to analyse the consequences of the Europe Agreements as well as the sensitivity of the results to important assumptions. The analysis shows only moderate long run gains for the Eastern Europe countries (around 1-2% of GDP per year), and very small gains for the EU countries. The sensitivity analysis shows that the results are relatively robust to the way the model is calibrated.