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Optimal time-consistent fiscal policy in an endogenous growth economy with public consumption and capital

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Abstract

In an endogenous growth model with public consumption and public investment, we explore the time-consistent optimal choice for two policy instruments: an income tax rate and the split of government spending between consumption and investment. We show that under the time-consistent, Markov policy, the economy lacks any transitional dynamics and also that there is local and global determinacy of equilibrium. We compare the Markovian optimal policy with the Ramsey policy as well as with the solution to the planner’s problem under lump-sum taxation. For empirically plausible parameter values we find that the Markov-perfect policy implies a higher tax rate and a larger proportion of government spending allocated to consumption than those chosen under a commitment constraint. As a result, economic growth is slightly lower under the Markov-perfect policy than under the Ramsey policy, with growth under lump-sum taxes being highest.

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  • Alfonso Novales Cinca & Rafaela María Pérez Sánchez & Jesús Rúiz Andújar, 2013. "Optimal time-consistent fiscal policy in an endogenous growth economy with public consumption and capital," Documentos de Trabajo del ICAE 2013-23, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales, Instituto Complutense de Análisis Económico.
  • Handle: RePEc:ucm:doicae:1323
    Note: The authors thank financial support received from the Spanish Ministry of Science and Innovation through grant ECO2009-10398, the Research Groups funding program by Universidad Complutense de Madrid and Banco Santander, the Xunta de Galicia through Grant 10PXIB300177PR and the Research Grant program in Economics at Fundación Ramón Areces.
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    1. Aschauer, David Alan, 1989. "Is public expenditure productive?," Journal of Monetary Economics, Elsevier, vol. 23(2), pages 177-200, March.
    2. Glomm, Gerhard & Ravikumar, B., 1997. "Productive government expenditures and long-run growth," Journal of Economic Dynamics and Control, Elsevier, vol. 21(1), pages 183-204, January.
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    Cited by:

    1. Novales, Alfonso & Pérez, Rafaela & Ruiz, Jesus, 2014. "Optimal time-consistent fiscal policy under endogenous growth with elastic labor supply," Economic Modelling, Elsevier, vol. 42(C), pages 398-412.

    More about this item

    Keywords

    Time-consistency; Markov-perfect optimal policy; Ramsey optimal policy; Endogenous growth; Income tax rate; Government spending composition.;

    JEL classification:

    • E61 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Policy Objectives; Policy Designs and Consistency; Policy Coordination
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H21 - Public Economics - - Taxation, Subsidies, and Revenue - - - Efficiency; Optimal Taxation

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