Climate Policy and Optimal Public Debt

This paper analyzes the optimal level of public debt when taxes are used not only for funding public expenditures but also for correcting externalities from climate change. Taking into account externalities may imply the optimal policy to deviate from tax smoothing. Provided accumulated marginal damages from today's consumption are larger than those from tomorrow's consumption, the inclusion of environmental externalities decreases (increases) optimal public debt if tax rates are on the increasing (decreasing) side of the Laffer curve. The reversed holds if the accumulated marginal damage increases over time. Allowing for endogenous adaptation investments reduces the deviation from tax smoothing.