Growth, Death, and Taxes

Abstract

A number of recent studies suggest that flat rate taxes may have important effects on long-run growth in the neoclassical growth model with human capital. In contrast to the traditional human capital literature, these studies assume that agents are infinitely lived and face constant returns in training. This paper shows that abstracting from life-cycle features and diminishing returns distorts growth effects in important ways. Analytical solutions for the growth effects of wage taxes are compared for finite and infinite horizon versions of the neoclassical growth model. The notion that growth effects with long but finite horizons are well approximated by infinite horizons is shown to be invalid, except in special cases. Generically, the assumptions made in the literature lead to a systematic overstatement of growth effects. Illustrative numerical results suggest that the discrepancies may be large.

JEL Classification: J24, O41