Optimal Taxation with Endogenous Default under Incomplete Markets
American Economic Journal: Macroeconomics
vol. 14,
no. 3, July 2022
(pp. 1-41)
Abstract
How are the optimal tax and debt policies affected if the government can default on its debt? We address this question from a normative perspective in an economy with noncontingent government debt, domestic default, and labor taxes. On one hand, default prevents the government from incurring future tax distortions associated with servicing the debt. On the other hand, default risk gives rise to endogenous credit limits that hinder the government's ability to smooth taxes. We characterize the fiscal policy and show how the option to default alters the near–unit root component of taxes in the economy with risk-free borrowing.Citation
Pouzo, Demian, and Ignacio Presno. 2022. "Optimal Taxation with Endogenous Default under Incomplete Markets." American Economic Journal: Macroeconomics, 14 (3): 1-41. DOI: 10.1257/mac.20160101Additional Materials
JEL Classification
- D52 Incomplete Markets
- E62 Fiscal Policy
- H21 Taxation and Subsidies: Efficiency; Optimal Taxation
- H24 Personal Income and Other Nonbusiness Taxes and Subsidies; includes inheritance and gift taxes
- H63 National Debt; Debt Management; Sovereign Debt
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