Growth and Welfare Effects of Tax Cuts: The Case of a Productive Public Input with Technological Risk

Ingrid Ott () and Susanne Soretz

Economic Change and Restructuring, 2004, vol. 31, issue 2, 117-135

Abstract: This paper analyzes the dynamic impact of tax cuts within a stochastic model of endogenous growth with a congested public input. A decreasing taxation of deterministic income parts leads to the well-known positive growth effect. Nevertheless, due to the insurance effect associated with the taxation of stochastic income flows, the overall growth impact of taxation is ambiguous. It is shown that the optimal structure of financing government expenditure does not only depend on the degree of rivalry but also on the degree of risk aversion. The optimal real value of government debt decreases with a rise in congestion. We identify that in the case of proportional congestion, the base for tax cuts should be the growth neutral consumption tax. Maximizing the growth rate does not automatically coincide with maximizing welfare. Hence, the base for tax cuts gains importance to realize a welfare optimal policy. Copyright Kluwer Academic Publishers 2004

Keywords: Tax cuts; congestion; uncertainty; growth (search for similar items in EconPapers)
Date: 2004
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DOI: 10.1007/s10663-004-1077-0

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