Fiscal Policy in an Endogenous Growth Model with Productive Government Spending

The goal of this paper is to analyse the effects of fiscal policy upon the long‐run balanced growth rate in an endogenous growth model in which sustained per capita growth is the result of productive government spending. Assuming that labour is supplied inelastically, it is shown that increases in non‐productive government spending, i.e. public consumption or lump‐sum transfers, always reduce the balanced growth rate, whereas there exists a growth‐maximizing investment subsidy rate and income tax rate. Moreover, a rise in a tax on consumption increases economic growth if it raises public investment. If labour supply is elastic the elasticity of labour supply crucially determines the growth‐maximizing income tax rate and an increase in the tax on consumption may raise or lower economic growth.