Optimal Fiscal Deficit in China under Fiscal Sustainability

Abstract: We have constructed a macroeconomic model that encompasses households, private enterprises, state-owned enterprises, and the government. In this model, households aim to maximize their utilities, while both private and state-owned enterprises strive for profit maximization. The government plays a dual role: firstly, it pursues the maximization of public goods utility under constrained conditions; secondly, it acts as a social planner, trading off the utility of resident households and the utility of public goods provided by the government, thereby seeking to maximize overall social welfare through taxation. In the process of maximizing public goods utility and overall social welfare, the government must make optimal decisions regarding government consumption, investment, held state assets, issued debt , asset utilization, and taxation. Based on this, we have derived the government’s optimal fiscal policy, which includes the optimal fiscal deficit and the limit on government debt as a percentage of GDP. We have estimated the fiscal deficit for 2023 and calculated the debt limit for the Chinese government, finding that there is still considerable room for adjustment in the issuance of government debt. Lastly, we discuss the standards stipulated in the European Union’s Maastricht Treaty, which sets the fiscal deficit limit at 3% and the debt-to-GDP ratio limit at 60%. We argue that the 3% fiscal deficit limit is unreasonable, as the optimal fiscal deficit should be determined through the government’s optimal decision-making process and also depends on economic growth rates as well as the government’s weighting of its own public goods utility. The debt-to-GDP ratio limit standard should be dynamically adjusted based on future fiscal deficits, economic growth rates, and interest rates, taking specific circumstances into account.