Fiscal Policy and Equitable Growth

Abstract

AbstractThis paper continues the study of optimal fiscal policy in a growing economy by exploring a case in which the government simultaneously provides three main categories of expenditures with distortionary tax finance: public production services, public consumption services, and state‐contingent redistributive transfers. The paper shows that in a general‐equilibrium model with given exogenous fiscal policy, a nonmonotonic relation exists between the suboptimal long‐run growth rate in a competitive economy and distortionary tax rates. When fiscal policy is endogenously chosen at a social optimum, the relation between the rate of growth and tax rates is always negative. These two properties suggest that an alternative set of government policy instruments affects the response of private sector investment to fiscal policy. Moreover, the different properties of exogenous and endogenous fiscal policy theoretically account for the difference in the relation between economic growth and fiscal policy in empirical studies.