Growth, Employment and Taxation with Distortions in the Goods and Labour Market

Abstract

Abstract This paper analyses taxation in the presence of distortions in goods and labour markets in an endogenous growth model. The government disposes of capital, labour and consumption taxes. It is shown that the market solution leads to suboptimally low levels of growth and employment. However, available tax instruments are sufficient to attain the first-best growth path in this economy. The paper further explores the relative distortion of capital and labour taxes. For plausible parametrisations of the model, lowering capital taxes dominate reductions in labour taxes in welfare terms.