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Optimal taxation in the presence of bailouts

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  • Panageas, Stavros
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    Abstract

    The 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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    File URL: http://www.sciencedirect.com/science/article/B6VBW-4XNF46S-1/2/c61595df8411cc52284803db6d9be1b1
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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Monetary Economics.

    Volume (Year): 57 (2010)
    Issue (Month): 1 (January)
    Pages: 101-116

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    Handle: RePEc:eee:moneco:v:57:y:2010:i:1:p:101-116

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    Web page: http://www.elsevier.com/locate/inca/505566

    Related research

    Keywords: Optimal taxation Guarantees Bailouts Continuous time optimization methods;

    References

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    1. Robert E. Lucas Jr. & Nancy L. Stokey, 1982. "Optimal Fiscal and Monetary Policy in an Economy Without Capital," Discussion Papers 532, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    2. Leland, Hayne E, 1994. " Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-52, September.
    3. Barro, Robert J, 1979. "On the Determination of the Public Debt," Journal of Political Economy, University of Chicago Press, vol. 87(5), pages 940-71, October.
    4. S. Rao Aiyagari & Albert Marcet & Thomas J. Sargent & Juha Seppala, 2002. "Optimal Taxation without State-Contingent Debt," Journal of Political Economy, University of Chicago Press, vol. 110(6), pages 1220-1254, December.
    5. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
    6. Lucas, Robert E, Jr, 1978. "Asset Prices in an Exchange Economy," Econometrica, Econometric Society, vol. 46(6), pages 1429-45, November.
    7. Merton, Robert C, 1978. "On the Cost of Deposit Insurance When There Are Surveillance Costs," The Journal of Business, University of Chicago Press, vol. 51(3), pages 439-52, July.
    8. Lucas, Deborah & McDonald, Robert L., 2006. "An options-based approach to evaluating the risk of Fannie Mae and Freddie Mac," Journal of Monetary Economics, Elsevier, vol. 53(1), pages 155-176, January.
    9. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
    10. George-Marios Angeletos, 2002. "Fiscal Policy With Noncontingent Debt And The Optimal Maturity Structure," The Quarterly Journal of Economics, MIT Press, vol. 117(3), pages 1105-1131, August.
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    Cited by:
    1. Horvath, B.L. & Huizinga, H.P., 2011. "Does the European Financial Stability Facility bail out Sovereigns or Banks? An Event Study," Discussion Paper 2011-118, Tilburg University, Center for Economic Research.

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