Public Debt and Economic Geography

This article studies the consequences of debt policies on the spatial distribution of output in a two-country model. It departs from the usual setup of local public finance by relaxing the assumption of balanced budget. Further, to single out the pure effect of debt, the article eliminates effects coming from tax and expenditure policies by assuming them exogenous and identical between countries except for the timing of taxation. Expected taxation rather than current tax levels motivates migration. Starting from an initial spatial configuration, be it Core-Periphery or symmetric equilibrium, the analysis identifies the critical thresholds of divergence or convergence of debt ratios which break the initial configuration. The article also shows that a high-debt country or a fast debt reducing country is a weaker player in the tax competition game. Finally, tax harmonization does not necessarily reduce migration flows.