Tax-Based Parallel Payment Systems: An Inquiry Into Their Economic Feasibility

This paper compares the potential of a tax-based parallel payment system as a solution to a shortage of liquidity in a highly leveraged country with the options of further debt assumption and sovereign debt default. A two-period game is used to analyze the best response of the state and the private sector and to identify under which conditions a tax-based parallel payment system would be preferred over foreign financing or default. The key variables affecting the decision of the state to implement or not the parallel payment system are, based on the model, the state of the economy, projected government expenditure, the cost of foreign financing versus domestic financing, the level of debt accumulated, the opportunity cost of current consumption of the private sector, and the subjective valuation of the future by the private sector. The private sector’s decision in equilibrium depends ultimately on the opportunity cost of current consumption and the level of taxation in the first period. Further recommendations include the segregation of the private sector into its constituents, the extension of the model to n periods, and the introduction of tax evasion and morale.