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 countercyclicality 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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Date of creation: Oct 2009
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Find related papers by JEL classification:
- E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
- H2 - Public Economics - - Taxation, Subsidies, and Revenue
- H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-10-17 (All new papers)
- NEP-MAC-2009-10-17 (Macroeconomics)
- NEP-PUB-2009-10-17 (Public Finance)
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