Working Paper: NBER ID: w15405
Authors: Stavros Panageas
Abstract: The termination of a representative financial firm due to excessive leverage may lead to substantial bankruptcy costs. A government in the tradition of Ramsey (1927) may be inclined to provide transfers to the firm so as to prevent its liquidation and the associated deadweight costs. It is shown that the optimal taxation policy to finance such transfers exhibits countercyclicality and history dependence, even in a complete market. These results are in contrast with pre-existing literature on optimal fiscal policy, and are driven by the endogeneity of the transfer payments that are required to salvage the financial firm.
Keywords: Optimal Taxation; Bailouts; Financial Firms; Countercyclicality; History Dependence
JEL Codes: E62; G28; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Government transfers to financial firms (G28) | Equilibrium allocations (D51) |
| Government transfers to financial firms (G28) | Consumer welfare (D69) |
| Optimal taxation policy (H21) | Tax rates (H29) |
| Tax rates (H29) | Output (Y10) |
| Tax rates (H29) | Net present value of required distortionary taxes (H31) |
| Past transfer payments (F16) | Current tax rates (H29) |