Why do the countries of the world display considerable disparity in long
term growth rates? This paper examines the hypothesis that the answer lies in
differences in national public policies which affect the incentives that
individuals have to accumulate capital in both its physical and human forms.
Our analysis shows that these incentive effects can induce large difference in
long run growth rates. Since many of the key tax rates are difficult to
measure, our procedure is an indirect one We work within a calibrated, two
sector endogenous growth model, which has its origins in the microeconomic
literature on human capital formation. We show that national taxation can
substantially affect long run growth rates. In particular, for small open
economies with substantial capital mobility, national taxation can readily lead
to "development traps" (in which countries stagnate or regress) or to "growth
miracles" (in which countries shift from little growth to rapid expansion)
This influence of taxation on the rate of economic growth has important welfare
implications: in basic endogenous growth models, the welfare cost of a 10 %
increase in the rate of income tax can be 40 times larger than in the basic
neoclassical model.
*Published:
Journal of Political Economy 98, October 1990, No. 5 part 2 5126-5150
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