Elasticity of Substitution and Growth Effects of Taxation

Abstract

In this thesis, we study the growth effects of taxation in a general two-sector endogenous growth model. We examines in particular how these effects depend on the elasticities of substitution between the factors in the final goods and human capital production. We find that the negative effects of taxation on economic growth are stronger when the elasticities of substitution between inputs are higher in both sectors. Under reasonable parameterization, for equal percentage changes, the labor income tax has a larger effect on growth than the capital income tax because the former has a larger tax base than the later. For revenue-equivalent changes, the magnitudes of the growth effects of the taxes depend on the elasticities of substitution: (i) when the elasticities are low, the capital income tax (the consumption tax) has a larger (smaller) effect on growth than the labor income tax; (ii) when the elasticities are high, the labor income tax (the consumption tax) has a larger (smaller) effect on growth than the capital income tax.