Public policy and economic growth: developing neoclassical implications

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 that affect the incentives that individuals have to accumulate capital in both its physical and human forms. 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' or to "growth miracles'. 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. -from Authors