Federalism, Taxation, and Economic Growth
Research Paper No. 1929
Federalism, Taxation, and Economic Growth
John William Hatfield January 2006
RESEARCH PAPER SERIES
Federalism, Taxation, and Economic Growth
John William Hat…eld Graduate School of Business Stanford University January 2006
Abstract We show that federalism will lead to higher economic growth. We present a model of endogenous growth where government services, funded by income and capital taxes, are a component of production. In this model a decentralized government will choose tax policy to maximize economic growth, while a centralized government will not do so. Furthermore, these conclusions hold regardless of whether the government is beholden to a median voter or is a rent-maximizing Leviathan. However, a decentralized government will underprovide a consumptive public good. Finally, we show our results are robust to imperfect capital mobility between districts and in such a model that districts with a lower total factor productivity will choose a more growth-enhancing tax policy.
The author may be contacted at hat…eld@stanford.edu. We are particularly obliged to Paul Milgrom and Romain Wacziarg for their guidance during the course of this research. We are also grateful to Syed Nageeb Mustafa Ali, B. Douglas Bernheim, William Hauk, Jr., Patricia MacriLassus, Ben Malin, Hui Li, Yuan-Chuan Lien, Daniel Quint, Antonio Rangel, Azeem Shaikh, and John Shoven for their helpful comments.
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Introduction
Determining the policies that increase economic growth is one of the foremost challenges for today’ economists. These questions are of enormous practical impors tance, as the welfare consequences of even small increases in economic growth can be tremendous.1 And yet, …nding these optimal economic policies is only half the job. Economic policy is not decided by benevolent social planners, but by government o¢ cials, usually with at least one eye to their reelection prospects. We consider the question of how
Federalism, Taxation, and Economic Growth
John William Hatfield January 2006
RESEARCH PAPER SERIES
Federalism, Taxation, and Economic Growth
John William Hat…eld Graduate School of Business Stanford University January 2006
Abstract We show that federalism will lead to higher economic growth. We present a model of endogenous growth where government services, funded by income and capital taxes, are a component of production. In this model a decentralized government will choose tax policy to maximize economic growth, while a centralized government will not do so. Furthermore, these conclusions hold regardless of whether the government is beholden to a median voter or is a rent-maximizing Leviathan. However, a decentralized government will underprovide a consumptive public good. Finally, we show our results are robust to imperfect capital mobility between districts and in such a model that districts with a lower total factor productivity will choose a more growth-enhancing tax policy.
The author may be contacted at hat…eld@stanford.edu. We are particularly obliged to Paul Milgrom and Romain Wacziarg for their guidance during the course of this research. We are also grateful to Syed Nageeb Mustafa Ali, B. Douglas Bernheim, William Hauk, Jr., Patricia MacriLassus, Ben Malin, Hui Li, Yuan-Chuan Lien, Daniel Quint, Antonio Rangel, Azeem Shaikh, and John Shoven for their helpful comments.
0
1
1
Introduction
Determining the policies that increase economic growth is one of the foremost challenges for today’ economists. These questions are of enormous practical impors tance, as the welfare consequences of even small increases in economic growth can be tremendous.1 And yet, …nding these optimal economic policies is only half the job. Economic policy is not decided by benevolent social planners, but by government o¢ cials, usually with at least one eye to their reelection prospects. We consider the question of how