Capital controls, collection costs and domestic public debt

The implications of a large public debt for the implementation of capital controls for an economy where tax revenue collection is costly are examined. Conditions are analyzed under which policymakers will resort to capital controls to reduce the cost of recycling domestic public debt. The linkages between a costly tax collection mechanism, capital controls, and domestic government debt are explored in terms of a two-period model of optimal taxation. Numerical simulations are provided to illustrate how capital controls are linked to different domestic public debt levels and to different degrees of efficiency in tax-revenue collection.