The Timing of Intergenerational Transfers, Tax Policy, and Aggregate Savings

We analyze the interest rate and savings effects of fiscal policy in an overlapping generations framework that accommodates two observations: (1) the interest rate on consumption loans exceeds the rate of return to household savings; and (2) private intergenerational transfers are widespread and primarily occur early in the life cycle of recipients. The wedge between borrowing and lending rates in our model arises from the asymmetric tax treatment of interest income and interest payments. Intergenerational transfers in our model are altruistically motivated. We prove the invariance of capital’s steady-state marginal product to government expenditures,government debt, the labor income-tax schedules, and the tax rate on capital income when borrowing rates exceed lending rates and at least some families are altruistically connected. In contrast, under the same conditions we find that the tax treatment of interest payments has powerful effects on capital’s marginal product.