Optimal Fiscal Policy with Heterogeneous Agents and Capital: Should We Increase or Decrease Public Debt and Capital Taxes?

François Le Grand and Xavier Ragot

Journal of Political Economy, 2025, vol. 133, issue 7, 2320 - 2369

Abstract: We analyze optimal fiscal policy in a heterogeneous-agent model with capital accumulation and aggregate shocks, where the government uses public debt, a capital tax, and a progressive labor tax to finance public spending. We first study a tractable model and show that the steady-state optimal capital tax can be positive if credit constraints are occasionally binding. However, the existence of such an equilibrium depends on the shape of the utility function. We also characterize the optimal dynamic of public debt after a public spending shock. We confirm these findings by solving for optimal policy in a general heterogeneous-agent model.

Date: 2025
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