Optimal Taxation in the Solow-Uzawa Growth Model with Public Goods

Abstract

This paper makes an original contribution to the literature of optimal taxation by introducing Ramseytaxation to the Solow-Uzawa growth model to examine genuine dynamic interdependence between growth andoptimal taxation. We introduce a public sector to the Uzawa two-sector growth model. The public sector suppliespublic goods and services. The government financially supports by the public sector by collecting taxes on thehousehold’s wage income and wealth income under the assumption that the utility level is maximized. We derivethe optimal taxation rule and construct the dynamics of the national economy. The model studies a nonlineardynamics between national and sectoral growth, economic structural change, wealth/capital accumulation, andoptimal tax rates in perfect competitive markets with the government intervention. The model has a uniquestable equilibrium point with the chosen parameter values. We carry out comparative dynamic analysis toanalyze effects of exogenous changes in a few parameters on the transitional process and long-term economicstructure of the economic dynamics.