The Design of Fiscal Reform Packages: Insights from a Theoretical Endogenous Growth Model
IMF Working Papers, July 22, 2016
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Bibliographic details
- Authors: Andrew Hodge
- Published: July 22, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498382199.001
Core model features
- The model draws together three key features of the endogenous growth literature:
- (i) investment in technology (in the form of human capital) offsets diminishing marginal productivity of private capital, allowing for perpetual growth in output per capita;
- (ii) changes in investment behavior because of cuts to distortionary tax rates impact long-run growth; and
- (iii) public capital has a role influencing total factor productivity and growth.
Quantitative simulation and main findings
- A quantitative simulation using reasonable parameter values suggests:
- Modest capital and/or labor income tax cuts and public investment increases have significant positive effects on consumer welfare but small effects on per capita income growth.
- Fiscal costs are offset by reductions in unproductive government spending in the scenarios where welfare improves.
- Capital income tax cuts and public investment increases continue to boost welfare when offset by consumption tax rises (rather than spending cuts).
- The welfare benefits of modest labor income tax cuts are outweighed by the costs of a compensating consumption tax increase.
Policy implications and reform-packages insights
- Combining modest tax cuts with public investment increases can raise consumer welfare even if effects on per capita income growth are small.
- Offsetting fiscal costs through reductions in unproductive government spending preserves welfare gains from tax cuts and public investment.
- Offsetting fiscal costs through consumption tax increases can maintain welfare gains from capital income tax cuts and public investment, but may negate gains from modest labor income tax cuts.