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Policy and Welfare Effects of Within-Period Commitment
Public expenditure is inefficiently low when a benevolent government can only commit to policies within a period. If the government loses the ability to commit within-period, then it stops internalizing some of the distortions created by current policy. Thus, to counterbalance the costs of future distortions, it increases public good provision, which may improve welfare. For a calibrated economy, removing within-period commitment implies a welfare gain worth half-a-percent of yearly consumption. A similar gain can be obtained, if instead, capital depreciation were allowed to be fully deducted from taxable income. However, enacting both reforms may lead to large welfare losses.