Dynamic Laffer Curves, Economic Growth and Public Capital

Abstract

This paper adds to the literature on tax policy and economic growth by examining the effects of tax cuts on labor and capital within an endogenous growth model with public capital and elastic labor supply. The impact of tax cuts on growth rates and government revenues is shown to vary significantly based on the allocation of government budgets towards government consumption, transfers, and investment in public capital. In general, governments that allocate their revenues to public capital investment enjoy higher growth rates and larger revenue gains from tax cuts than governments that allocate to transfers or government consumption. In addition, cuts in capital tax rates are more likely to generate a positive present value of future revenues than similar cuts in labor tax rates. That is, capital taxes are more likely to have a dynamic Laffer curve. These results are explained at the microeconomic level through substitution, income and government outlay effects.