Consumption tax and economic growth in an overlapping generations model with money holdings

Abstract

This paper examines the effect of a consumption tax on economic growth using an overlapping generations (OLG) model with money holdings. We show that the neutrality of the consumption tax does not hold in the money-in-the-utility-function model, because a change in consumption taxation induces the substitution of money holdings for consumption, and the money is the net wealth within the OLG structure. An increase in the consumption tax rate lowers (raises) the growth rate under a low (high) monetary expansion rate. On the other hand, in the cash-in-advance model and the money-in-the-production-function model, the neutrality of consumption taxation holds even within the OLG structure, because in these models there is no substitution of consumption and money holdings.