Optimal taxation in the presence of bailouts
AbstractThe termination of a representative financial firm due to excessive leverage may lead to substantial bankruptcy costs. A government in the tradition of Ramsey (1927) may be inclined to provide transfers to the firm so as to prevent its liquidation and the associated deadweight costs. It is shown that the optimal taxation policy to finance such transfers exhibits procyclicality and history dependence, even in a complete market. These results are in contrast with pre-existing literature on optimal fiscal policy, and are driven by the endogeneity of the transfer payments that are required to salvage the financial firm.
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Bibliographic InfoArticle provided by Elsevier in its journal Journal of Monetary Economics.
Volume (Year): 57 (2010)
Issue (Month): 1 (January)
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Web page: http://www.elsevier.com/locate/inca/505566
Optimal taxation Guarantees Bailouts Continuous time optimization methods;
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