On the Non-Existence of a Zero-Tax Steady State with Incomplete Asset Markets

Previous analyses suggest that a government can finance its expenditure by only using its asset income without taxes in the long run. We show that uninsured idiosyncratic earnings risk may overturn this result. In an Aiyagari-type model, we theoretically show that increasing government assets eventually decreases the interest rate below zero, suggesting an upper bound on government asset income. Hence, when government expenditure exceeds a threshold, there exists no zero-tax steady-state equilibrium, and the zero-tax policy is infeasible. Quantitatively, a government can raise small revenues without taxes. Increasing government assets may also generate rational asset price bubbles.