A note on optimal fiscal policy in an economy with private borrowing limits

•A model with non-distortionary taxes, heterogeneous households, and borrowing constraints is proposed.•Tax financing tightens private borrowing constraints whereas public debt financing relaxes them.•For high public debt, private borrowing constraints are fully relaxed and Ricardian equivalence holds.•Optimal policy preserves binding borrowing constraints so as to reduce interest rates on public debt.

We consider the implications for optimal fiscal policy when taxes are non-distortionary and households are heterogeneous and borrowing constrained. The main result is that optimal policy keeps some households borrowing constrained in order to reduce interest rates on government debt.