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Public debt and fiscal policy traps

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  • Camous, Antoine
  • Gimber, Andrew R.

Abstract

We present a theory linking the cyclicality of tax policy to inherited public debt. When debt is low, tax policy is countercyclical, in the sense that the government responds to low output by setting a low tax rate. Above a threshold level of debt, however, optimal tax policy becomes procyclical. This creates the possibility of self-fulfilling crises (“fiscal policy traps”), in which output is low because households expect high taxes, and the government sets high taxes because output is low. Our model suggests why highly indebted governments might implement procyclical tax policy even without facing high sovereign risk premia.

Suggested Citation

  • Camous, Antoine & Gimber, Andrew R., 2018. "Public debt and fiscal policy traps," Journal of Economic Dynamics and Control, Elsevier, vol. 93(C), pages 239-259.
    • Handle: RePEc:eee:dyncon:v:93:y:2018:i:c:p:239-259
    DOI: 10.1016/j.jedc.2018.02.009
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    Cited by:

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    2. Canh Phuc NGUYEN & Christophe SCHINCKUS, 2020. "The Spending Behavior of Government through the Lenses of Global Uncertainty and Economic Integration," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(2), pages 35-57, July.
    3. Froemel, Maren & Paczos, Wojtek, 2024. "Imperfect financial markets and the cyclicality of social spending," European Economic Review, Elsevier, vol. 167(C).
    4. Maxime Menuet & Alexandru Minea & Patrick Villieu, 2019. "Increasing Returns, Balanced-Budget Rules, and Aggregate Fluctuations," Working Papers hal-02153853, HAL.
    5. Canh Phuc Nguyen & Thanh Dinh Su, 2022. "When ‘uncertainty’ becomes ‘unknown’: Influences of economic uncertainty on the shadow economy," Annals of Public and Cooperative Economics, Wiley Blackwell, vol. 93(3), pages 677-716, September.
    6. Thanh, Su Dinh & Canh, Nguyen Phuc, 2020. "Taxation and capital formation: Non-linear effects and asymmetry between developing and developed countries," The Journal of Economic Asymmetries, Elsevier, vol. 22(C).
    7. Akhmad Syakir Kurnia & Syahid Izzulhaq & Johan Beni Maharda & Agung Kunaedi, 2021. "Inflation and Financial Stability Trade‐off: Role of Monetary Policy Credibility and Fiscal Cyclicality," Economic Papers, The Economic Society of Australia, vol. 40(1), pages 31-53, March.

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    More about this item

    Keywords

    Public debt; Tax policy cyclicality; Coordination failures; Expectation traps; Laffer curve;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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