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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
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Society for Economic Dynamics Marina Azzimonti Department of Economics Stonybrook University 10 Nicolls Road Stonybrook NY 11790 USA

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  1. Barro, Robert J., 1979. "On the Determination of the Public Debt," Scholarly Articles 3451400, Harvard University Department of Economics.
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