On the Non-Existence of a Zero-Tax Steady State with Incomplete Asset Markets

Abstract

Previous analyses suggest that a government can finance its expenditure by only using its asset income without taxes in the long run. We show that uninsured idio-syncratic earnings risk may overturn this result. In an Aiyagari-type model, we the-oretically show that increasing government assets eventually decrases the interest rate below zero, suggesting an upper bound on government asset income. Hence, when government expenditure exceeds a threshold, there exists no zero-tax steady-state equilibrium, and the zero-tax policy is infeasible. Quantitatively, a government can raise small revenues without taxes. Increasing government assets may also gen-erate rational asset price bubbles.