This chapter analyzes the abrupt reduction of government expenditure that allowed reducing the deficit after 1985 – backing the Israeli economy to successfully confront the challenges of the 1990s. We analyze the reasons for the reduction of defense expenditure and we show that this feature was crucial for creating an historical regime shift in Israeli Fiscal Policy.

This paper calculates optimal linear income taxes when differences in income are caused by random factors (‘luck’) rather than by unobserved individual skills, as assumed in the classical theory of income taxation. As first shown by Varian (1980) [Varian, H.R., 1980. Redistributive taxation as social insurance, Journal of Public Economics 14, 49–68] in the former case income taxation acts as social insurance. By introducing life uncertainty and precautionary behavior, we find higher optimal marginal tax rates than those found by Varian. We also find that – in the context of a piecewise two-bracket linear tax schedule – the second marginal tax is higher than the first, a finding that contrasts with results recently obtained in the framework of classical income taxation theory, which show a lower second marginal tax.

A crucial assumption for the solution of the endogenous growth model with government intervention is a balanced budget along the perpetual steady state. This assumption is unreal once we are interested to test the model using government data, given that in most countries the budget is not balanced. In this letter we adopt the well-known rule of ‘tax smoothing’ in order to make this assumption a realistic one. According to our approach the relevant variable for the implementation of a balanced budget is permanent government expenses. The empirical performance of the model is characterized using Israeli data.

In this study we perform a time series analysis of economic growth in Israel, a  country that in its short history vas been characterized by sharp changes in the public sector budget deficit and its composition. We found that the endogenous growth model is more suitable for Israeli data than the classical exogenous growth model. The paper also provides a framework for dealing with unbalanced budgets in the context of the endogenous growth model.  According to our theoretical model and empirical findings for Israel, the permanent taxes are a better measure than actual taxes of their influence on growth.

It is well known that "pure" Ricardian equivalence fails whenever there is a nonzero probability for a corner solution in the future. The interesting question remains whether consumers seem more Keynesian or more Ricardian (by consuming or saving, respectively, a substantial portion of an announced and noncontingent tax cut). For the case of income uncertainty, and assuming precautionary behavior, I have shown that the answer depends on the characteristics of the corner solutions. If the corner solution has to do with parental poverty (when marginal utility is sensitive to extra consumption), the transfer given by the government allows for a substantial reduction of precautionary savings and consequently the departure from Ricardian equivalence looks Keynesian. If it has to do with children's wealth, marginal utility is less sensitive to extra consumption, and consequently the results appear Ricardian. This finding stresses the importance of differentiating among different types of income uncertainty.

A subsequent generations model is used to characterize consumption allocation under the future generation's income uncertainty. Altruistic concerns toward the future generation gives rise to precautionary bequests which act as a hedge on risk. It is shown that given a first-order correlation between mean future income and the present generation's income, government intervention can provide a Pareto improvement through a tax-transfer policy with universal participation. This policy acts as a substitute for precautionary bequests. Distributional aspects of the tax-transfer policy are also discussed.

This paper considers insurance aspects in the demand price of coal as a way of hedging price uncertainty. The paper shows an empirical assessment of insurance aspects and its implications for the price of coal.

Life and income uncertainty are modeled simultaneously in order to analyze the influence of perfecting income insurance in the size of bequests and demand for annuities. The main result shows that government intervention aimed at providing intergenerational risk sharing acts as a bequest substitute, and if annuities are available, reduces the demand for annuities.

Deviating from marginal cost is a common practice in oil products pricing. Israeli pricing set deviations according to the price relationships of an exogenous selected market.   In this paper we compare this solution with the solution obtained from a maximizer social planner model that takes into account efficiency and income distribution considerations. Through welfare index calculations and comparative statics exercises we show that welfare can be affected by exogenous developments from the point of view of the local market.