Domestic Taxes and the External Debt Laffer Curve

Abstract

This paper highlights the role of the domestic tax system in determining the economic consequences of an external debt overhang. The analysis indicates that fairly strong, and probably unrealistic, assumptions about the domestic tax system are needed to argue that the investment disincentives associated with the debt overhang are large enough to place a country on the wrong side of the debt Laffer curve. A simple taxation scheme is specified, and it is shown that a country can be on the ‘wrong side’ of its debt Laffer curve only if it is on the wrong side of its tax Laffer curve.

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