Exogenous spending in models of endogenous growth

Abstract

The literature of endogenous growth yields atypical solutions for optimal Ąnancing policies. In an environment with productive, exogenous spending, it is optimal to levy capital-income taxes, even if the government has access to non-distortionary instruments. Furthermore, when government spending approaches its optimal value, the capital income tax converges to zero. These results contradict the underlying assumption that the governmentŠs Ąnancing and spending decisions can be made independently of each other. The literature cannot properly explain this result, nor does it grasp its economic signiĄcance. I show these results are not inherent to the models used to derive them. In fact, they stem from the assumption of exogenous spending, speciĄcally how it is set. The common framework in the endogenous growth literature is to set government spending as an exogenous share of output. When considering a reasonable deviation on this assumption, I show that non-distortionary taxes are indeed an optimal Ąnancing instrument. Thus, it is possible to implement optimal economic trajectories, while verifying the separability assumption.

Date of Award	1 Feb 2024
Original language	English
Awarding Institution	Universidade Católica Portuguesa
Supervisor	Pedro Teles (Supervisor)