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Optimal size of the government: the role of the elasticity of substitution

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  • Manuel Gómez

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Abstract

This paper analyzes the optimal fiscal policy in an endogenous growth model with productive public services. Government expenditure, which may be subject to different degrees of congestion, is financed by distortionary income taxation. The standard result on the equality between the growth-maximizing, welfare-maximizing and first-best income tax rates holds if and only if production is Cobb–Douglas or there is proportional congestion. With non-proportional (or in the absence of) congestion, the first-best income tax is lower than the (second-best) welfare-maximizing income tax which, in turn, is lower than the growth-maximizing income tax if the elasticity of substitution is below unity. Under mild conditions these relations are reversed if the elasticity of substitution is above unity. Intuition on these results is also provided. Copyright Springer-Verlag Wien 2014

Suggested Citation

  • Manuel Gómez, 2014. "Optimal size of the government: the role of the elasticity of substitution," Journal of Economics, Springer, vol. 111(1), pages 29-53, February.
    • Handle: RePEc:kap:jeczfn:v:111:y:2014:i:1:p:29-53
    DOI: 10.1007/s00712-012-0317-1
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    References listed on IDEAS

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    More about this item

    Keywords

    Optimal policy; Public expenditure; Elasticity of substitution; O41; E21;

    JEL classification:

    • O41 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - One, Two, and Multisector Growth Models
    • E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth

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