Optimal Taxation and Debt Management without Commitment
This paper considers optimal fiscal policy in a deterministic Lucas and Stokey (1983) economy in the absence of government commitment. In every period, the government chooses a labor income tax and issues any unconstrained maturity structure of debt as a function of its outstanding debt portfolio. We find that the solution under commitment cannot always be sustained through the appropriate choice of debt maturities, a result which contrasts with previous conclusions in the literature. This is because a government today cannot commit future governments to a particular side of the Laffer curve, even if it can commit them to future revenues. We find that the unique stable debt maturity structure under no commitment is flat, with the government owing the same amount of resources to the private sector at all future dates. We present examples in which the maturity structure converges to such a flat distribution over time. In cases where the commitment and no-commitment solutions do not coincide, debt converges to the natural debt limit.
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Document Object Identifier (DOI): 10.3386/w24522