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Public Finance in Models of Economic Growth

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  • Barro, Robert J.
  • Sala-i-Martin, Xavier

Abstract

The recent literature on endogenous economic growth allows for the effects of fiscal policy on long-term growth. If the social rate of return on investment exceeds the private return, tax policies that encourage investment can raise the growth rate and levels of utility. An excess of the social return over the private return can reflect learning-by-doing with spillover effects, the financing of government consumption purchases with an income tax, and monopoly pricing of new types of capital goods. Tax incentives for investment are not called for if the private rate of return on investment equals the social return. This situation applies in growth models if the accumulation of a broad concept of capital does not entail diminishing returns, or if technological progress appears as an expanding variety of consumer products. In growth models that incorporate public services, the optimal tax policy hinges on the characteristics of the services. If the public services are publicly-provided private goods, that are rival and excludable, or publicly-provided public goods, that are non-rival and non-excludable, lump-sum taxation is superior to income taxation. Many types of public goods are subject to congestion, however, and are therefore rival but to some extent non-excludable. In these cases, income taxation works approximately as a user fee and can therefore be superior to lump-sum taxation. In particular, the incentives for investment and growth are too high if taxes are lump sum. We argue that the congestion model applies to a wide array of public expenditures, including transportation facilities, public utilities, courts and possibly national defence and the police.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 630.

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Date of creation: Mar 1992
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Handle: RePEc:cpr:ceprdp:630

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Keywords: Economic Growth; Fiscal Policies; Public Finance;

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References

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  1. King, Robert G & Rebelo, Sergio T, 1993. "Transitional Dynamics and Economic Growth in the Neoclassical Model," American Economic Review, American Economic Association, vol. 83(4), pages 908-31, September.
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  8. Dixit, Avinash K & Stiglitz, Joseph E, 1975. "Monopolistic Competition and Optimum Product Diversity," The Warwick Economics Research Paper Series (TWERPS) 64, University of Warwick, Department of Economics.
  9. Rebelo, Sergio, 1991. "Long-Run Policy Analysis and Long-Run Growth," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 99(3), pages 500-521, June.
  10. Abel, Andrew B & Blanchard, Olivier J, 1983. "An Intertemporal Model of Saving and Investment," Econometrica, Econometric Society, Econometric Society, vol. 51(3), pages 675-92, May.
  11. Tjalling C. Koopmans, 1963. "On the Concept of Optimal Economic Growth," Cowles Foundation Discussion Papers, Cowles Foundation for Research in Economics, Yale University 163, Cowles Foundation for Research in Economics, Yale University.
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