On taxation in a two-sector endogenous growth model with endogenous labor supply

Abstract

This paper studies the effects of taxation on long-run growth in a two-sector endogenous growth model with (i) physical capital as an input in the education sector and (ii) leisure as an additional argument in the utility function. Income taxation – the same rate applies for capital and labor income – reduces the growth rate. The same is true if only labor income is taxed. However, if only capital income is taxed, the positive effect of an increase in total non-leisure time may dominate the direct negative effect, implying that capital taxation increases the long-run growth rate.