Department of Economics University of Cyprus Endogenous Public Policy and Long-run Growth

We study the determinants of voting outcomes on the provision of public consumption through marginal income taxes in the context of the simple linear growth model. We focus on how the dynamic politicoeconomic equilibrium maps the economic fundamentals to policies and long-run growth. We find that in a deterministic growth environment voters internalize, although imperfectly, the deadweight losses of taxation and vote for lower taxes when the productivity of capital is higher. Therefore, the politicoeconomic channel reinforces the positive role of productivity for growth. In a stochastic environment, we find that if business cycles are driven by productivity shocks in the endogenous growth framework, equilibrium policies imply that taxes should fall in high growth periods and rise in low-growth periods. In line with existing evidence, our model predicts procyclical public consumption and countercyclical public consumption GDP shares.