Optimal taxation with endogenous default under incomplete markets by Demian Pouzo and Ignacio Presno
By: Pouzo, Demian
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Contributor(s): Presno, Ignacio.
Material type: 
ArticleSubject(s): DEUDA PUBLICA | POLITICA FISCAL | IMPOSICION OPTIMA | CREDITO | MODELOS ECONOMETRICOS
In:
American Economic Journal : Macroeconomics v. 14, n. 3, July 2022, p. 1-41Summary: 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.
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| OP 2137/2022/2 American Economic Journal : Macroeconomics | OP 2137/2022/2-1 High marginal tax rates on the top 1 percent? | OP 2137/2022/3 American Economic Journal : Macroeconomics | OP 2137/2022/3-1 Optimal taxation with endogenous default under incomplete markets | OP 2137/2022/3-2 Dynamic capital tax competition under the source principle | OP 2137/2022/4 American Economic Journal : Macroeconomics | OP 2137/2022/4-1 Expectations-driven liquidity traps |
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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.
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