Notes on Optimal Debt Management

Robert J. Barro

71 citations0/0 files storedJournal of Applied Economics

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Fiscal Policies and Political Economy Economic and Fiscal Studies Fiscal Policy and Economic Growth

Abstract

Consider the finance of an exogenous path of public expenditure, G(t), with taxes and public debt issues.In the absence of unexpected default, borrowing does not allow the government to escape taxes in a present-value sense.But the choices of how much to borrow and in what form affect the timing of tax collections and the ways in which these collections are contingent on economic outcomes.This note assesses these choices from an optimal-tax perspective.That is, the government manages its debt to minimize the expected present value of the distortions from financing its expenditures.The optimal-tax solution can be analyzed in three stages.In the first stage, the conditions hold for Ricardian equivalence, so that choices between debt and taxes do not matter.Sufficient conditions for this result are lumpsum taxes; certainty about future levels of income, public spending, rates of return, etc.; perfect capital markets; and infinite horizons for households.Under these conditions, the known present value of taxes is fixed by the given path of government spending.This result-the absence of a free lunch for the government-applies as long as the government cannot pursue Ponzi schemes or chain letters in which the public debt can grow faster than the economy forever.In this case, public borrowing can change the timing of taxes but not the present value.Therefore, the issue of an extra dollar of debt to cut current taxes by one dollar implies an increase by one dollar in the present value of future taxes.With lump-sum taxes, infinite horizons, and perfect capital markets, the representative household cares only about the present value of taxes.The timing of these levies does not matter.Since a deficit-financed tax cut does

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References

1989The Ricardian Approach to Budget Deficits 2016Tax Smoothing with Financial Instruments 1988Why do we have nominal government debt?1990Indexation and maturity of government bonds: an exploratory model 1990Confidence crises and public debt management

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