Optimal taxation in the presence of bailouts
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 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.
|Date of creation:||Oct 2009|
|Date of revision:|
|Publication status:||published as “Optimal taxation in the presence of bailouts'', Journal of Monetary Economics, 2010, 57(1), pp. 101-116|
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