IDEAS home Printed from https://ideas.repec.org/a/kap/jeczfn/v111y2014i1p29-53.html
   My bibliography  Save this article

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

Author

Listed:
  • Manuel Gómez

    ()

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
    as

    Download full text from publisher

    File URL: http://hdl.handle.net/10.1007/s00712-012-0317-1
    Download Restriction: Access to full text is restricted to subscribers.

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Turnovsky, Stephen J., 2002. "Intertemporal and intratemporal substitution, and the speed of convergence in the neoclassical growth model," Journal of Economic Dynamics and Control, Elsevier, vol. 26(9-10), pages 1765-1785, August.
    2. Turnovsky, Stephen J, 1996. "Fiscal Policy, Adjustment Costs, and Endogenous Growth," Oxford Economic Papers, Oxford University Press, vol. 48(3), pages 361-381, July.
    3. Wong, Tsz-Nga & Yip, Chong K., 2010. "Indeterminacy and the elasticity of substitution in one-sector models," Journal of Economic Dynamics and Control, Elsevier, vol. 34(4), pages 623-635, April.
    4. Palivos, Theodore & Karagiannis, Giannis, 2010. "The Elasticity Of Substitution As An Engine Of Growth," Macroeconomic Dynamics, Cambridge University Press, vol. 14(5), pages 617-628, November.
    5. Florian Misch & Norman Gemmell & Richard Kneller, 2013. "Growth and Welfare Maximization in Models of Public Finance and Endogenous Growth," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 15(6), pages 939-967, December.
    6. Andreas Irmen & Rainer Klump, 2009. "Factor Substitution, Income Distribution and Growth in a Generalized Neoclassical Model," German Economic Review, Verein für Socialpolitik, vol. 10(4), pages 464-479, November.
    7. Devarajan, Shantayanan & Swaroop, Vinaya & Heng-fu, Zou, 1996. "The composition of public expenditure and economic growth," Journal of Monetary Economics, Elsevier, vol. 37(2-3), pages 313-344, April.
    8. Sugata Ghosh & Andros Gregoriou, 2008. "The composition of government spending and growth: is current or capital spending better?," Oxford Economic Papers, Oxford University Press, vol. 60(3), pages 484-516, July.
    9. Turnovsky, Stephen J., 1997. "Fiscal Policy In A Growing Economy With Public Capital," Macroeconomic Dynamics, Cambridge University Press, vol. 1(3), pages 615-639, September.
    10. Xue, Jianpo & Yip, Chong K., 2012. "Factor Substitution And Economic Growth: A Unified Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 16(4), pages 625-656, September.
    11. Eicher, Theo & Turnovsky, Stephen J, 2000. "Scale, Congestion and Growth," Economica, London School of Economics and Political Science, vol. 67(267), pages 325-346, August.
    12. Robert J. Barro & Xavier Sala-I-Martin, 1992. "Public Finance in Models of Economic Growth," Review of Economic Studies, Oxford University Press, vol. 59(4), pages 645-661.
    13. Azariadis, Costas, 1996. "The Economics of Poverty Traps: Part One: Complete Markets," Journal of Economic Growth, Springer, vol. 1(4), pages 449-496, December.
    14. Alberto Bucci & Chiara Del Bo, 2012. "On the interaction between public and private capital in economic growth," Journal of Economics, Springer, vol. 106(2), pages 133-152, June.
    15. Guo, Jang-Ting & Lansing, Kevin J., 2009. "Capital-labor substitution and equilibrium indeterminacy," Journal of Economic Dynamics and Control, Elsevier, vol. 33(12), pages 1991-2000, December.
    16. Barro, Robert J, 1990. "Government Spending in a Simple Model of Endogenous Growth," Journal of Political Economy, University of Chicago Press, vol. 98(5), pages 103-126, October.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Manuel Gómez, 2016. "Factor substitution is an engine of growth in a model with productive public expenditure," Journal of Economics, Springer, vol. 117(1), pages 37-48, January.
    2. Dimitrios Paparas & Christian Richter, 2015. "Fiscal policy and economic growth: Empirical evidence from the European Union," Working Papers 2015.06, International Network for Economic Research - INFER.
    3. Oliviero A. Carboni & Paolo Russu, 2013. "A Model of Economic Growth with Public Finance: Dynamics and Analytic Solution," International Journal of Economics and Financial Issues, Econjournals, vol. 3(1), pages 1-13.
    4. Dioikitopoulos, Evangelos V. & Kalyvitis, Sarantis, 2008. "Public capital maintenance and congestion: Long-run growth and fiscal policies," Journal of Economic Dynamics and Control, Elsevier, vol. 32(12), pages 3760-3779, December.
    5. Rainer Klump & Peter McAdam & Alpo Willman, 2012. "The Normalized Ces Production Function: Theory And Empirics," Journal of Economic Surveys, Wiley Blackwell, vol. 26(5), pages 769-799, December.
    6. Alberto Bucci & Chiara Del Bo, 2012. "On the interaction between public and private capital in economic growth," Journal of Economics, Springer, vol. 106(2), pages 133-152, June.
    7. Florian Misch & Norman Gemmell & Richard Kneller, 2013. "Growth and Welfare Maximization in Models of Public Finance and Endogenous Growth," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 15(6), pages 939-967, December.
    8. Benos, Nikos, 2009. "Fiscal policy and economic growth: empirical evidence from EU countries," MPRA Paper 19174, University Library of Munich, Germany.
    9. Manuel A. Gómez, 2008. "Fiscal Policy, Congestion, and Endogenous Growth," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 10(4), pages 595-622, August.
    10. Ingrid Ott & Stephen J. Turnovsky, 2006. "Excludable and Non‐excludable Public Inputs: Consequences for Economic Growth," Economica, London School of Economics and Political Science, vol. 73(292), pages 725-748, November.
    11. Ott, Ingrid & Soretz, Susanne, 2008. "Growth strategies: Fiscal versus institutional policies," Economic Modelling, Elsevier, vol. 25(4), pages 605-622, July.
    12. Calderon, Cesar & Serven, Luis, 2014. "Infrastructure, growth, and inequality : an overview," Policy Research Working Paper Series 7034, The World Bank.
    13. Chatterjee, Santanu & Turnovsky, Stephen J., 2007. "Foreign aid and economic growth: The role of flexible labor supply," Journal of Development Economics, Elsevier, vol. 84(1), pages 507-533, September.
    14. Xue, Jianpo & Yip, Chong K., 2012. "Factor Substitution And Economic Growth: A Unified Approach," Macroeconomic Dynamics, Cambridge University Press, vol. 16(4), pages 625-656, September.
    15. Andreas Irmen & Johanna Kuehnel, 2009. "Productive Government Expenditure And Economic Growth," Journal of Economic Surveys, Wiley Blackwell, vol. 23(4), pages 692-733, September.
    16. Jianpo Xue & Chong K. Yip, 2015. "Balanced-Budget Rules, Elasticity of Substitution, and Macroeconomic (In)Stability," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 17(2), pages 196-218, April.
    17. Gupta, Manash Ranjan & Barman, Trishita Ray, 2010. "Health, infrastructure, environment and endogenous growth," Journal of Macroeconomics, Elsevier, vol. 32(2), pages 657-673, June.
    18. Felice, Giulia, 2016. "Size and composition of public investment, sectoral composition and growth," European Journal of Political Economy, Elsevier, vol. 44(C), pages 136-158.
    19. Shu‐Hua Chen & Jang‐Ting Guo, 2018. "On Indeterminacy and Growth under Progressive Taxation and Utility‐Generating Government Spending," Pacific Economic Review, Wiley Blackwell, vol. 23(3), pages 533-543, August.
    20. Andreas Irmen & Johanna Kuehnel, 2009. "Productive Government Expenditure And Economic Growth," Journal of Economic Surveys, Wiley Blackwell, vol. 23(4), pages 692-733, September.

    More about this item

    Keywords

    Optimal policy; Public expenditure; Elasticity of substitution; O41; E21;
    All these keywords.

    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

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:kap:jeczfn:v:111:y:2014:i:1:p:29-53. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sonal Shukla) or (Springer Nature Abstracting and Indexing). General contact details of provider: http://www.springer.com .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.