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Optimal Time-Consistent Taxation with Default
We study optimal time-consistent distortionary taxation when the repayment of government debt is not enforceable. The government taxes labor income or issues noncontingent debt in order to finance an exogenous stream of stochastic government expenditures. The government can repudiate its debt subject to some default costs, thereby introducing some state-contingency to debt. We are motivated by the fact that domestic sovereign default is an empirically relevant phenomenon, as Reinhart and Rogoff (2011) demonstrated. Optimal policy is characterized by two opposing incentives: an incentive to ...
Optimal Fiscal Policy with Recursive Preferences
I study the implications of recursive utility, a popular preference specification in macrofinance, for the design of optimal fiscal policy. Standard Ramsey tax-smoothing prescriptions are substantially altered. The planner overinsures by taxing less in bad times and more in good times, mitigating the effects of shocks. At the intertemporal margin, there is a novel incentive for introducing distortions that can lead to an ex-ante capital subsidy. Overall, optimal policy calls for a much stronger use of debt returns as a fiscal absorber, leading to the conclusion that actual fiscal policy is ...
A Tax Plan for Endogenous Innovation
In times when elevated government debt raises concerns about dimmer global growth prospects, we ask: How can the government provide incentives for innovation in a fiscally sustainable way? We address this question by examining the Ramsey problem of finding optimal tax and subsidy schemes in a model in which growth is endogenously sustained by risky innovation. We characterize the shadow value of growth and entry in the innovation sector. We find that a profit tax is required to replicate the first-best in order to balance the externalities associated with innovative activity. At the ...