Hakki Yazici
Slavík Ctirad
Kina Özlem
Tilman Graff
Tilman Graff
Yuri Ostrovsky
Martin Munk
Anton Heil
Maitreesh Ghatak
Robin Burgess
Oriana Bandiera
Claire Balboni
Jonna Olsson
Richard Foltyn
Minjie Deng
Iiyana Kuziemko
Elisa Jácome
Juan Pablo Rud
Bridget Hofmann
Sumaiya Rahman
Martin Nybom
Stephen Machin
Hans van Kippersluis
Anne C. Gielen
Espen Bratberg
Jo Blanden
Adrian Adermon
Maximilian Hell
Robert Manduca
Robert Manduca
Marta Morazzoni
Aadesh Gupta
David Wengrow
Damian Phelan
Amanda Dahlstrand
Andrea Guariso
Erika Deserranno
Lukas Hensel
Stefano Caria
Vrinda Mittal
Ararat Gocmen
Clara Martínez-Toledano
Yves Steinebach
Breno Sampaio
Joana Naritomi
Diogo Britto
François Gerard
Filippo Pallotti
Heather Sarsons
Kristóf Madarász
Anna Becker
Lucas Conwell
Michela Carlana
Katja Seim
Joao Granja
Jason Sockin
Todd Schoellman
Paolo Martellini
UCL Policy Lab
Natalia Ramondo
Javier Cravino
Vanessa Alviarez
Hugo Reis
Pedro Carneiro
Raul Santaeulalia-Llopis
Diego Restuccia
Chaoran Chen
Brad J. Hershbein
Claudia Macaluso
Chen Yeh
Xuan Tam
Xin Tang
Marina M. Tavares
Adrian Peralta-Alva
Carlos Carillo-Tudela
Felix Koenig
Joze Sambt
Ronald Lee
James Sefton
David McCarthy
Bledi Taska
Carter Braxton
Alp Simsek
Plamen T. Nenov
Gabriel Chodorow-Reich
Virgiliu Midrigan
Corina Boar
Sauro Mocetti
Guglielmo Barone
Steven J. Davis
Nicholas Bloom
José María Barrero
Thomas Sampson
Adrien Matray
Natalie Bau
Darryl Koehler
Laurence J. Kotlikoff
Alan J. Auerbach
Irina Popova
Alexander Ludwig
Hakki Yazici
Slavík Ctirad
Kina Özlem
Tilman Graff
Tilman Graff
Yuri Ostrovsky
Martin Munk
Anton Heil
Maitreesh Ghatak
Robin Burgess
Oriana Bandiera
Claire Balboni
Jonna Olsson
Richard Foltyn
Minjie Deng
Iiyana Kuziemko
Elisa Jácome
Juan Pablo Rud
Bridget Hofmann
Sumaiya Rahman
Martin Nybom
Stephen Machin
Hans van Kippersluis
Anne C. Gielen
Espen Bratberg
Jo Blanden
Adrian Adermon
Maximilian Hell
Robert Manduca
Robert Manduca
Marta Morazzoni
Aadesh Gupta
David Wengrow
Damian Phelan
Amanda Dahlstrand
Andrea Guariso
Erika Deserranno
Lukas Hensel
Stefano Caria
Vrinda Mittal
Ararat Gocmen
Clara Martínez-Toledano
Yves Steinebach
Breno Sampaio
Joana Naritomi
Diogo Britto
François Gerard
Filippo Pallotti
Heather Sarsons
Kristóf Madarász
Anna Becker
Lucas Conwell
Michela Carlana
Katja Seim
Joao Granja
Jason Sockin
Todd Schoellman
Paolo Martellini
UCL Policy Lab
Natalia Ramondo
Javier Cravino
Vanessa Alviarez
Hugo Reis
Pedro Carneiro
Raul Santaeulalia-Llopis
Diego Restuccia
Chaoran Chen
Brad J. Hershbein
Claudia Macaluso
Chen Yeh
Xuan Tam
Xin Tang
Marina M. Tavares
Adrian Peralta-Alva
Carlos Carillo-Tudela
Felix Koenig
Joze Sambt
Ronald Lee
James Sefton
David McCarthy
Bledi Taska
Carter Braxton
Alp Simsek
Plamen T. Nenov
Gabriel Chodorow-Reich
Virgiliu Midrigan
Corina Boar
Sauro Mocetti
Guglielmo Barone
Steven J. Davis
Nicholas Bloom
José María Barrero
Thomas Sampson
Adrien Matray
Natalie Bau
Darryl Koehler
Laurence J. Kotlikoff
Alan J. Auerbach
Irina Popova
Alexander Ludwig

Inequality, taxation, and sovereign default risk

What is this research about and why did you do it?

Income inequality affects fiscal policies related to taxation, borrowing, and default. This research is driven by the empirical observation that governments in more unequal economies are more likely to default and face higher debt spreads. This pattern is evident in both US state-level and international data. The paper aims to explain and quantify how inequality influences fiscal outcomes and debt sustainability. By examining the interplay between redistribution policies, worker behavior, and debt repayment, this study provides deeper insights into the fiscal challenges posed by rising inequality.

How did you answer this question?

I develop a sovereign default model that incorporates income inequality, endogenous taxation, and labor mobility to capture the interactions between taxation, debt, and inequality. In the model, workers are heterogeneous in income, supplying labor elastically and consuming after-tax income. They can also migrate by paying an idiosyncratic cost, making labor elastic along both intensive (labor supply) and extensive (migration) margins. The government chooses a nonlinear tax scheme, debt, and default policy. Progressive taxation redistributes income but reduces labor supply and induces high-income emigration, eroding the tax base and increasing default risk, creating a trade-off between redistribution and debt sustainability.

What did you find?

Governments face a trade-off between redistribution and debt default risk. A more progressive tax redistributes income and reduces inequality but discourages labor and increases sovereign default risk. In an economy where inequality is a key concern, the government opts for more redistribution and has higher spreads. Calibrated to US state-level data, inequality accounts for one-fifth of the average spread. During recessions, the interaction between income inequality and migration amplifies negative productivity shocks, limiting the government’s ability to adjust taxes and further increasing debt spreads.

Note: This table compares the average sovereign spread and debt-to-GDP ratio in equilibrium between the benchmark model and a model without income inequality.

After a one standard deviation negative productivity shock, the government spread goes up in all models (panel A)

         

 

What implications does this have for the study (research and teaching) of wealth concentration or economic inequality?

This research highlights the intricate connection between economic inequality and fiscal sustainability. For both research and teaching, it underscores how progressive taxation can simultaneously reduce inequality and increase sovereign default risk, especially in economies with high inequality. It emphasizes the importance of considering labour mobility and fiscal policies when studying economic inequality and wealth concentration.

What are the next steps in your agenda?

Motivated by the findings in this paper, future work will explore the financial and fiscal connections between sovereign debt crises and the labour market, aiming to better understand how these linkages impact government policy decisions and broader macroeconomic outcomes.

Citation and related resources

Deng, M., 2024. Inequality, taxation, and sovereign default risk. American Economic Journal: Macroeconomics, 16(2), pp.217-249.

About the authors