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Inequality, Taxation, and Sovereign Default Risk

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Abstract
Income inequality and worker migration significantly affect sovereign default risk. Governments often impose progressive taxes to reduce inequality, which redistribute income but discourage labor supply and induce emigration. Reduced labor supply and a smaller high-income workforce erode the current and future tax base, reducing the government’s ability to repay debt. I develop a sovereign default model with endogenous non-linear taxation and heterogeneous labor to quantify this effect. In the model, the government chooses the optimal combination of taxation and debt, considering its impact on workers’ labor and migration decisions. With the estimated model, I find that income inequality and its interactions with migration explain one-third of the average U.S. state government spread.

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  • Minjie Deng, 2021. "Inequality, Taxation, and Sovereign Default Risk," Discussion Papers dp21-15, Department of Economics, Simon Fraser University.
    • Handle: RePEc:sfu:sfudps:dp21-15
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    Cited by:

    1. Farzana Alamgir & Alok Johri, 2022. "International Sovereign Spread Differences and the Poverty of Nations," Department of Economics Working Papers 2022-06, McMaster University.
    2. Minjie Deng & Chang Liu, 2021. "Sovereign Risk and Intangible Investment," Discussion Papers dp21-16, Department of Economics, Simon Fraser University.
    3. Cuesta, Lizeth, 2020. "Efecto del crecimiento demográfico en la deuda externa. Estudio para países sudamericanos usando un análisis de cointegración [Effect of population growth on external debt. Study for South American," MPRA Paper 111041, University Library of Munich, Germany, revised 11 Apr 2021.
    4. George Liontos & Konstantinos Mavrigiannakis & Eugenia Vella, 2023. "The Macroeconomics of Skills Mismatch in the Presence of Emigration," DEOS Working Papers 2314, Athens University of Economics and Business.
    5. Tran-Xuan, Monica, 2023. "Optimal redistributive policy in debt constrained economies," Journal of International Economics, Elsevier, vol. 144(C).

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    More about this item

    JEL classification:

    • D31 - Microeconomics - - Distribution - - - Personal Income and Wealth Distribution
    • F34 - International Economics - - International Finance - - - International Lending and Debt Problems
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation
    • H23 - Public Economics - - Taxation, Subsidies, and Revenue - - - Externalities; Redistributive Effects; Environmental Taxes and Subsidies
    • H74 - Public Economics - - State and Local Government; Intergovernmental Relations - - - State and Local Borrowing
    • J61 - Labor and Demographic Economics - - Mobility, Unemployment, Vacancies, and Immigrant Workers - - - Geographic Labor Mobility; Immigrant Workers
    • R23 - Urban, Rural, Regional, Real Estate, and Transportation Economics - - Household Analysis - - - Regional Migration; Regional Labor Markets; Population

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