The Optimal Borrowing Tax

The Optimal Borrowing Tax

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Optimal public finance analysis of intertemporal models has been devoted to special cases where the distortion of intertemporal choice is avoided. In contrast, practical public finance has significant distortion of intertemporal choice. This paper characterizes optimal intertemporal taxation in a simple model. With distortionary taxation necessary, fluctuations of productivity of external real interest rates are potent possible reasons to distort intertemporal choice. Borrowing/lending taxation is shown to be generally required for efficiency, even in the special separable case usually thought to imply no intertemporal distortion. The time profile of the optimal borrowing/lending tax is characterized in a special case, and the resulting relation between optimal public debt and the trade account is analyzed.