Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/200520 
Year of Publication: 
2017
Series/Report no.: 
Working Paper No. 2017-12
Publisher: 
Federal Reserve Bank of Atlanta, Atlanta, Ga.
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.
Subjects: 
labor tax
sovereign default
Markov-perfect equilibrium
time-consistency
generalized Euler equation
long-term debt
JEL: 
D52
E43
E62
H21
H63
Document Type: 
Working Paper

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