Tax-mix, public spending composition and growth

This paper characterizes optimal fiscal policy in an endogenous growth model whose policy implications are consistent with the relationship between two stylized facts observed in a majority of OECD economies, namely the growth in the ratios of both government consumption to public investment and of direct to indirect taxation from 1970 to 2004. Assuming a continuation in the upward trend for the public consumption to output ratio consistent with that observed for this variable between 1970 and 2004 for most developed economies, we find that the optimal tax system becomes more intensive in income taxation relative to consumption taxation, and that public disbursements become less intensive in public investment, which is consistent with the co-evolution of these ratios over the last 40 years.