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Optimal redistributive policy in debt constrained economies

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  • Tran-Xuan, Monica

Abstract

How should governments with a preference for redistribution design tax policies when facing limited borrowing? This paper studies optimal taxation in a small open economy with heterogeneous agents and endogenous debt constraints arising from the government's limited commitment to fiscal policies. The optimal labor tax decreases over time and is nonzero in the limit, and the optimal capital and domestic borrowing taxes are positive in the limit, deviating from the standard Ramsey tax results. The government's redistributive motive directly affects optimal tax levels, whereas binding debt constraints influence optimal tax dynamics. In the numerical analysis, a stronger redistributive preference requires greater initial tax distortions and a higher external debt level in the long run.

Suggested Citation

  • Tran-Xuan, Monica, 2023. "Optimal redistributive policy in debt constrained economies," Journal of International Economics, Elsevier, vol. 144(C).
    • Handle: RePEc:eee:inecon:v:144:y:2023:i:c:s0022199623000715
    DOI: 10.1016/j.jinteco.2023.103785
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    More about this item

    Keywords

    Optimal taxation; Redistribution; Limited commitment; Sovereign debt;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • F38 - International Economics - - International Finance - - - International Financial Policy: Financial Transactions Tax; Capital Controls
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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