| In this thesis, I analyze a dynamic optimal taxation problem in a closed economy under incomplete markets allowing for default on the government debt. The government's objective is to smooth the distortions across time originated by labor taxes. The government faces an exogenous stochastic stream of expenditures that needs to be financed; in order to finance this, apart from levying taxes, the government can issue non-state contingent debt, and can also default on its debt at any time. Households predict the possibility of default, thereby generating endogenous debt limits, which hinder the government's ability to smooth shocks using debt. This in turn increases the volatility of the taxes.;If the government defaults, it goes to temporary financial autarky -- where it can only levy taxes to finance expenditures -- and it can only exit by paying a certain fraction of the defaulted debt. The possibility of paying may not arrive immediately; thus, in the meantime, households trade the defaulted debt in secondary markets. The equilibrium price in this market is used to price the debt during the default period.;I characterize the optimal default decision, optimal tax and debt policy of the government, the equilibrium prices of the government debt and the set of implementable allocations. Quantitative exercises match various qualitative features observed in the data for emerging economies. |
