Tax evasion and default risk
In this paper Pappadà and Zylberberg introduce a model of sovereign debt with limited commitment and imperfect tax enforcement. They find that:
- In economies with high tax evasion governments, during default crises, tend to implement austerity policies;
- These policies lead to a vicious circle: high tax rates generate long-run distortions which increase default risk, forcing the government to persevere with austerity policies.
These findings illustrate how imperfect tax enforcement may constrain the set of feasible fiscal policies during default crises. They may justify the polarized debate on recovery, some policy makers advocating for extreme austerity with others promoting expansionary fiscal policies.
Sovereign Default and Imperfect Tax Enforcement
Authors: Francesco Pappadà, Yanos Zylberberg
From: Banque de France, University of Bristol
Almost always, defaults are partial
A central idea in our theory is that partial default is an alternative way to effectively borrow and inter-temporally transfer resources. […] Unlike standard borrowing, however, partial default does not have the acquiescence of the lenders and is associated with future resource costs. A main implication of our theory is that partial default is an amplifying force for debt crises. A country that misses payments will be in worse shape going forward because it will experience rising debt as the defaulted payments accumulate and any new borrowing occurs at high interest rates. This theory is capable of rationalizing the large heterogeneity in partial default, its comovements with economic outcomes, and rising debt during default episodes.
Partial Default
Authors: Cristina Arellano, Xavier Mateos-Planas, José-Víctor Ríos-Rull
From: Federal Reserve Bank of Minneapolis, Queen Mary University of London, University of Pennsylvania
