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Fiscal Policy in Debt Constrained Economies

  • Manuel Amador

    (Stanford University)

  • Mark Aguiar

    (University of Rochester)

We study optimal fiscal policy in a small open economy (SOE) with sovereign and private default risk. The SOE's government uses linear taxation to fund exogenous expenditures and uses public debt to inter-temporally allocate tax distortions. We characterize a class of environments in which the tax on labor goes to zero in the long run, while the tax on capital income may be non-zero,reversing the standard prediction of the Ramsey tax literature. The zero labor tax is an optimal long run outcome if the private agents are impatient relative to the international interest rate and the economy is subject to private and/or sovereign debt constraints. We show that a similar result holds in a closed economy with imperfect inter-generational altruism.

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Paper provided by Society for Economic Dynamics in its series 2011 Meeting Papers with number 527.

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Date of creation: 2011
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Handle: RePEc:red:sed011:527
Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Web page: http://www.EconomicDynamics.org/society.htm
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  13. Carmen M. Reinhart & Kenneth S. Rogoff, 2009. "This Time Is Different: Eight Centuries of Financial Folly," Economics Books, Princeton University Press, edition 1, volume 1, number 8973, April.
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  18. Dominguez, Begona, 2007. "Public debt and optimal taxes without commitment," Journal of Economic Theory, Elsevier, vol. 135(1), pages 159-170, July.
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