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Normative Fiscal Policy and Growth: Some Quantitative Implications for the Chilean Economy

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  • Emilio Espino
  • Martín González Rozada

Abstract

This paper explores the qualitative and quantitative implications of optimal taxation in a developing economy when economic growth is endogenously determined. We differentiate this class of economies from a developed economy in two aspects: informal sector is quantitatively significant and tax-collecting technologies are more rudimentary. We characterize competitive equilibrium allocations and Ramsey allocations in the context of a small open economy in which the interest rate is endogenously determined, some workers can be hired in the informal market, and imperfect tax-collecting technology can be heterogeneous across different types of taxes. We calibrate the parameters of our model to the Chilean economy. Overall, our results suggest that capital should still be taxed but considerably less than actual taxes (that is, 10.78 percent versus 18.5 percent). Labor should be subsidized (to stimulate accumulation of human capital), while consumption taxes should be increased by 50 percent approximately (from 19 percent to 28 percent). As expected, the better the tax collecting technologies, the higher the corresponding taxes. In this context, the resulting growth rate increases only slightly along the balanced growth path.

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Bibliographic Info

Paper provided by Inter-American Development Bank in its series IDB Publications with number 82531.

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Date of creation: Sep 2013
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Handle: RePEc:idb:brikps:82531

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Keywords: Economic Development & Growth; Fiscal Policy; Optimal fiscal growth; economic growth; inefficient tax collecting technology;

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  1. Stephanie Schmitt-Grohe & Martin Uribe, 2001. "Closing Small Open Economy Models," Departmental Working Papers 200115, Rutgers University, Department of Economics.
  2. Neumeyer, Pablo A. & Perri, Fabrizio, 2005. "Business cycles in emerging economies: the role of interest rates," Journal of Monetary Economics, Elsevier, vol. 52(2), pages 345-380, March.
  3. King, R.G. & Rebelo, S., 1988. "Public Policy And Economic Growth: Developing Neoclassical Implications," RCER Working Papers 225, University of Rochester - Center for Economic Research (RCER).
  4. Lars Ljungqvist & Thomas J. Sargent, 2004. "Recursive Macroeconomic Theory, 2nd Edition," MIT Press Books, The MIT Press, edition 2, volume 1, number 026212274x, December.
  5. Lucas, Robert E, Jr, 1990. "Supply-Side Economics: An Analytical Review," Oxford Economic Papers, Oxford University Press, vol. 42(2), pages 293-316, April.
  6. Jones, Larry E & Manuelli, Rodolfo E & Rossi, Peter E, 1993. "Optimal Taxation in Models of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 101(3), pages 485-517, June.
  7. Rodrigo Fuentes & Mauricio Larraín & Klaus Schmidt-Hebbel, 2006. "Sources of Growth and Behavior of TFP in Chile," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 43(127), pages 113-142.
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