Optimal Time-Consistent Taxation with Default

Anastasios Karantounias

No 2017-12, FRB Atlanta Working Paper from Federal Reserve Bank of Atlanta

Abstract: We study optimal time-consistent distortionary taxation when the repayment of government debt is not enforceable. The government taxes labor income or issues noncontingent debt in order to finance an exogenous stream of stochastic government expenditures. The government can repudiate its debt subject to some default costs, thereby introducing some state-contingency to debt. We are motivated by the fact that domestic sovereign default is an empirically relevant phenomenon, as Reinhart and Rogoff (2011) demonstrated. Optimal policy is characterized by two opposing incentives: an incentive to postpone taxes by issuing more debt for the future and an incentive to tax more currently in order to avoid punishing default premia. A generalized Euler equation (GEE) captures these two effects and determines the optimal back-loading or front-loading of tax distortions.

Keywords: labor tax; sovereign defaults; Markov-perfect equilibrium; time-consistency; generalized Euler equation; long-term debt (search for similar items in EconPapers)
JEL-codes: D52 E43 E62 H21 H63 (search for similar items in EconPapers)
Pages: 44 pages
Date: 2017-11-01
New Economics Papers: this item is included in nep-dge, nep-mac, nep-pbe and nep-pub
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Citations: View citations in EconPapers (4)

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Working Paper: Optimal time-consistent taxation with default (2015)
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