Fiscal Policy and Economic Growth

One view of government fiscal policy is that it stifles dynamic economic growth through the distortionary effects of taxation and inefficient government spending. Another view is that government plays a central role in economic development by providing public goods and infrastructure. This paper develops a generalized model of fiscal policy and output growth that allows for (i) a positive or negative effect of government spending on private productivity, (ii) increasing or decreasing returns to scale, (iii) a transition path away from the equilibrium growth path, and (iv) intratemporal tax distortions. Using data from 107countries during the period 1970-85,and correcting for the potentially serious problem of endogeneity in government policy, we find that a balanced-budget increase in government spending and taxation is predicted to reduce output growth rates.