Managing Government Debt and Taxes in the Age of Climate Change

Abstract

In this study, we develop a model for managing government debt and taxes when facing climate risk. We find that the mitigation of climate risk significantly increases household value and a country’s debt capacity and lowers the marginal costs of servicing debt. Moreover, the government lowers the amount of mitigation spending because of the crowding-out effect of taxes. Finally, debt results in a greater willingness to pay for mitigation because mitigation technology can effectively lower the degree of default risk by reducing the degree of climate risk.

Keywords: sovereign debt, default, limited commitment, Ricardian equivalence, debt capacity, debt sustainability