Productive Government Spending Research Articles

Intertemporal equilibrium with physical capital and financial asset: Role of dividend taxation

The paper introduces dividend taxation and productive government spending in an infinite-horizon general equilibrium model with heterogeneous agents and financial market imperfections. We point out that imposing a dividend tax and using the revenue from this tax to finance productive government spending may prevent economic recession and promote economic growth. We also investigate the issue of optimal dividend taxation and the role of dividend taxation on the asset price bubble.

Optimal fiscal policy with low interest rates for government debt

This paper analyzes optimal fiscal policy when the rate at which governments can borrow changes persistently. To analyze trade-offs, we allow for fiscal distortions and productive government spending and characterize the optimal mix between spending and revenue measures in a low rate environment. We find that low interest rates on government bonds can be welfare-enhancing if used by the government for fiscal measures that reduce the level of distortion, notably the labor tax, permanently. In the case of a general "flight-to-quality”, where households ask for a premium for holding physical (private) capital, the optimal policy is to increase the public-to-private capital ratio for as long as the shock persists. The associated financing needs should be met by a small increase in government debt and a temporary capital tax.

Optimal fiscal policies and market structures with monopolistic competition

This paper develops a unified imperfectly competitive macroeconomic model, and uses it to analyze optimal fiscal policies in the presence of market imperfections. The salient feature of the model is that it is able to deal with three distinct types of market structure, including constant monopoly firms, endogenous monopoly firms and endogenous overhead costs. Several findings emerge from the analysis. First, the extent of production externalities will vary under the three distinct market structures, and in turn lead the government to implement different labor and capital tax policies to correct the different extents of the distortions. Second, the optimal ratio of government expenditure is determined solely by the extent of productive government spending if the number of firms is constant, while the optimal ratio is related to the internal increasing returns to scale and production specialization if the number of firms is determined endogenously. Finally, free entry in the competitive equilibrium may result in over entry or under entry, depending upon the relative degree between monopoly power and production specialization.

The golden rule of public finance under active monetary stance: endogenous setting for a developing economy

The paper aims to verify the introduction of the golden rule of public finance under an active monetary stance for a developing economy using a dynamic stochastic general equilibrium model. Besides the two rigidities, namely the deep habit formation and Calvo-style price stickiness, the model structure incorporates real money holdings and welfare-enhancing government purchases in the utility-generating function and a modified Taylor rule. The simulation results have validated the visible crowding-out of private consumption and investment in the short run and a positive impact of the productive government spending on long-run growth, but with some important caveats. In the case of a developing economy that usually has low efficiency and high returns to public capital, the given factors prove significant in addressing the study issue. The results are robust in terms of the structure of utility-generating function, a relatively high share of liquidity-constrained households, and a degree of price stickiness. Moreover, to offset the debt accumulation as a result of increased public investment financing by persistent output growth, in the long run, the central bank should not only rely on response to the fluctuation of inflation and output but also account for a move of public debt.

Time‐varying consumption tax, productive government spending, and aggregate instability

AbstractIn this paper we investigate if government balanced‐budget rules together with endogenous taxation may lead to aggregate instability in an endogenous growth framework. After highlighting the differences with the exogenous growth framework, we prove that under counter‐cyclical consumption taxes, while there exists a unique balanced growth path, sunspot equilibria based on self‐fulfilling expectations occur through a form of global indeterminacy. In addition, we argue that this result is empirically plausible for a large set of OECD countries and that it may also emerge with endogenous income taxes.

Industrial structure and economic performance: The role of productive public expenditure

AbstractI consider productive government spending and preference for diversity in an imperfectly competitive macroeconomic framework, and analyze how differences in industrial structure affect economic growth and the welfare level. Two main findings emerge from the analysis. First, the optimal ratio of government spending is related to the extent of public expenditure externalities and preference for diversity. Second, the vertical separation regime leads to a higher economic growth rate and welfare level than the vertical integration regime, provided that the degree of monopoly power is relatively small.

Public policy, dynamic status preferences, and wealth inequality

AbstractThis paper studies the effect of productive government spending (taxation) on aggregate savings behavior and its consequences for the dynamics of wealth inequality, taking into consideration key behavioral changes that occur during the process of economic development. Substantial empirical evidence suggests that during this process agents' preferences toward status (positional consumption) evolves according to the average wealth of the society. The sources of wealth include private capital and productive public capital, the latter financed by a distortionary income tax. This dynamic status effect impacts peoples' responses to tax policy in ways which contrast with those of the standard neoclassical model. Specifically, we find that in response to an increase in the income tax, in economies with a strong (weak) enough dynamic status effect, savings and inequality increase (decrease). Incorporating the behavioral changes to fiscal policy expands the set of mechanisms available to explain the observed variations of savings and wealth distribution dynamics that cannot be attributed to technological or other structural factors.

The Direct and Indirect (Spillover) Effects of Productive Government Spending on State Economic Growth

AbstractUsing data on 48 contiguous U.S. states and a spatial econometric approach, this paper examines short‐ and long‐run effects of productive higher education and highway infrastructure spending financed by different revenue sources on state economic growth. Following the Lagrange Multiplier, Wald, and Likelihood Ratio tests, the data are found to be characterized by both spatial lag and spatial error processes, leading to the estimation of a dynamic spatial Durbin model. By decomposing results of the dynamic spatial Durbin model into short‐ and long‐run direct as well as indirect (spillover) effects, we show that accounting for spillover effects provides a more comprehensive approach to uncovering the effects of productive government spending on growth. We find that, regardless of the financing source, productive higher education and highway spending have statistically significant short‐ and long‐run direct as well as spillover effects on state income growth.

Is Gerontocracy Harmful for Growth? a Comparative Study of Seven European Countries

We study the relationship between gerontocracy and aggregate economic performance in a simple model where growth is driven by human capital accumulation and productive government spending. We show that less patient élites display the tendency to underinvest in public education and productive government services, and thus are harmful for growth. The damage caused by gerontocracy is mainly due to the lack of long-term delayed return on investments, originated by the lower subjective discount factor. An empirical analysis using public investment in Information and Communication Technologies (ICT) is carried out to test theoretical predictions across different countries and different economic sectors. The econometric results confirm our main hypotheses.

Macroeconomic (in)stability and endogenous market structure with productive government expenditure

AbstractWe consider the congestion effect of productive government spending in a monopolistic competition model with endogenous entry, and analyze the possibility of local indeterminacy. Some main findings emerge from the analysis. First, the indeterminacy condition is independent of the monopoly power. Second, productive government expenditure can be a source of local indeterminacy, while a higher degree of public goods congestion lessens the beneficial effect of productive government expenditure, and therefore reduces the possibility of indeterminacy. Third, a higher degree of internal returns to scale is associated with a lower possibility for the emergence of indeterminacy when production externalities are present.

Vertical separation versus vertical integration in an endogenously growing economy

This paper sets up an endogenous growth model with a learning-by-doing externality in capital accumulation under both vertical separation and vertical integration structures. Some major findings emerge from our analysis. First, an increase in monopoly power has a detrimental effect on the balanced growth rate. Second, a vertical integration structure leads to a more balanced economic growth rate than a vertical separation structure. Third, the first-best subsidy rates on labor income and capital income under a vertical separation regime are higher than those under a vertical integration regime. Finally, with the additional externality from productive government spending, the government may levy positive taxes on both labor income and capital income if the extent of the productive public spending externality is sufficiently high.

Government size, institutions, and export performance among OECD economies

With a panel of 18 OECD countries, 1980–2005, we investigate the determinants of export performance, in particular the effects of the size of government and institutional features. In a model of endogenous extent of domestically-produced goods, government size has a non-linear effect on export performance; the export-maximising size of government (tax receipts) is around 40–45% of GDP; the best size of productive government spending is around 16% of GDP. Product market and labour market-related rigidities affect negatively the export performance both on their own and via a negative effect on the effectiveness of R&D and slow down the speed of adjustment. Among traditional variables, relative unit labour cost, R&D shares in GDP, TFP growth and human capital show up significantly and with the expected signs.

Productive government spending and its consequences for the growth–inequality tradeoff

This paper investigates the effects of productive government spending on the relationship between growth and inequality in an economy subject to idiosyncratic production shocks and heterogeneous endowments. Assuming lognormal distributions, we derive tractable closed form solutions describing the equilibrium dynamics. We show how the effect of government investment on the equilibrium dynamics of both inequality and growth depends crucially upon the elasticity of substitution between public and private capital in production. This has important consequences for the growth- and welfare-maximizing rates of government investment. Finally, we supplement our theoretical analysis with numerical simulations, calibrated to approximate the productive characteristics of a real world economy. With the empirical evidence strongly supporting the complementarity between public and private capital, our simulations suggest that conclusions based on the commonly employed Cobb–Douglas production function may be seriously misleading.

Implications of productive government spending for fiscal policy

The standard assumption in macroeconomics that government spending is unproductive can have substantive implications for tax and spending policy. Productive government spending introduces a positive feedback between the tax rate, the productive capacity of the economy, and tax revenue. We allow marginal tax revenue to be optimally allocated between productive subsidies to human capital and utility-enhancing government consumption and calculate Laffer Curves for the US. Productive government spending yields higher revenue-maximizing tax rates, steeper slopes at low tax rates and higher peaks. The differences are particularly pronounced for the labor-tax Laffer curve. The use of tax revenue is an important determinant of the actual revenue that a tax rate increase generates.

On indeterminacy and growth under progressive taxation and productive government spending

AbstractWe examine the theoretical interrelations between equilibrium (in)determinacy and economic growth in a one‐sector representative‐agent model of endogenous growth with progressive taxation of income and productive flow of public spending. We analytically show that, if the demand‐side effect of government purchases is weaker, the economy exhibits an indeterminate balanced‐growth equilibrium and belief‐driven growth fluctuations when the tax schedule is sufficiently progressive or regressive. If the supply‐side effect of public expenditures is weaker, indeterminacy and sunspots arise under progressive income taxation. In sharp contrast to traditional Keynesian‐type stabilization policies, our analysis finds that raising the tax progressivity may destabilize an endogenously growing economy with fluctuations driven by agents’ self‐fulfilling expectations.

When Elders Rule: Is Gerontocracy Harmful for Growth?

We study the relationship between gerontocracy and aggregate economic perfomance in a simple model where growth is driven by human capital accumulation and productive government spending. We show that gerontocratic elites display the tendency to underinvest in public education and productive government services and thereby may be harmful growth. In absence of intergenerational altruism, the damage caused by gerontocracy is mainly due to the lack in long-term delayed-return investment originated by the shorter life horizon of the ruling class with respect to the rest of the population. An empirical analysis is carried out on a rich data set that al lows to test theoretical results across different countries and different sectors. The econometric results confirm our main hypotheses.

Progressive taxation and macroeconomic (In) stability with productive government spending

This paper systematically examines the interrelations between a progressive income tax schedule and macroeconomic (in)stability in an otherwise standard one-sector real business model with productive government spending. We analytically show that the economy exhibits indeterminacy and sunspots if and only if the equilibrium after-tax wage-hours locus is positively sloped and steeper than the household's labor supply curve. Unlike in the framework with useless public expenditures, a less progressive tax policy may operate like an automatic stabilizer that mitigates belief-driven cyclical fluctuations. Moreover, our quantitative analysis shows that this result is able to provide a theoretically plausible explanation for the discernible reduction in US output volatility after the Tax Reform Act of 1986 was implemented.

Long-Run Growth and Welfare Effects of Rising US Public Health Expenditure

The continuing increase of the US public health spending would inevitably lead to a reduction in productive government spending, higher taxes, or both. If the government enacts any of the policies, to what extent would the rising health care spending affect the long-run economic growth and welfare? Using an endogenous growth model where investment in education is the driving force of growth, our quantitative analysis shows that if health is a consumption good, such policies will reduce long-run growth and welfare. To finance public health spending at 20 percent of gross domestic product (GDP), a policy that simultaneously reduces productive government spending and raises tax rates could decrease the long-run growth by 0.7 percentage points and welfare by 14 percent. When health is both consumption and productive good, this policy reduces long-run growth and welfare modestly.

AID ALLOCATION, GROWTH AND WELFARE WITH PRODUCTIVE PUBLIC GOODS

ABSTRACTThis paper develops an open‐economy intertemporal growth model with endogenous relative prices and an imperfect world capital market. The government provides infrastructure and health services, which are both productive. The model is calibrated for a ‘typical’ low‐income country and used to examine the growth and welfare effects of both permanent and temporary, tied and untied, increases in aid. Simulation results show that aid tied to productive government spending delivers high growth rates and substantial welfare gains, without leading to a sustained real appreciation, only if the efficiency of public expenditure (a proxy for the quality of governance) is sufficiently high. The presence of production externalities has important implications for the path of the real exchange rate. Copyright © 2012 John Wiley & Sons, Ltd.

Corruption in a neoclassical growth model with a non-convex production function: comment

In Pereira and da Cruz Vieira (Int Rev Econ 57:335–346, 2010), it is claimed that previous studies on corruption using the neoclassical growth model in the Ramsey tradition typically exploited a convex production function with productive government spending. Moreover, a non-convex intensive form technology representation is proposed as derived from the (presumptive) strictly convex function in levels. We show that none of these claims are true, for the general function is neither convex nor concave and fails to be linearly homogeneous. As a consequence, all the findings derived in Pereira and da Cruz Vieira (2010) are not peculiar to non-convex production functions.