Abstract
The IMF Working Papers series is designed to make IMF staff research available to a wide audience. Almost 300 Working Papers are released each year, covering a wide range of theoretical and analytical topics, including balance of payments, monetary and fiscal issues, global liquidity, and national and international economic developments.
The paper develops a one-sector aggregate endogenous growth model with intertemporal preference dependence. In addition to its conceptual appeal, the endogenous time preference construct provides a rigorous basis for generating meaningful transitional dynamics even within the confines of a simple one-sector model. The model has two important attractive attributes: (i) in contrast to those of the neoclassical and most other endogenous growth models with constant time preferences, its transitional dynamics do not instantaneously vanish in the face of a perfect international capital market, because the implied intertemporal elasticity of substitution with a time-varying time preference changes along the path of transition to the steady state; and (ii) it avoids the necessity of employing more complex, multi-sector models in analyzing many growth issues, which invariably diminish analytical transparency and tractability.
The specific model examined possesses the fundamental property of growth convergence, that is, countries with identical parameters regarding technology, preference, and government policy will converge to a steady state with the same (positive) growth rate. At the same time, the model is not necessarily inconsistent with the large differences in cross-country growth rates which may be observed over prolonged periods of time, since such differences could well be attributable to the lengthiness of the transition, among other things. However, the plausibility of this explanation will not be known until quantitative simulations of the model based on specific parameter values have been carried out.
A notable tax policy implication of the model concerns the growth effects of an income tax. In virtually all endogenous growth models in the literature, an income tax, by reducing the net-of-tax return to capital, exerts a negative impact on growth, unless the tax revenue is used to finance some productive public good, such as infrastructure. In a model with endogenous time preference, income tax will still lower the net-of-tax return to capital at an unchanged rate of savings. However, the rate of savings will be raised, as the tax depresses consumption, which in turn has a positive impact of growth. Hence, even in the absence of externalities, the model shows that the growth effects of an income tax are ambiguous and dependent on the relative magnitudes of the tax rate and the tax elasticity of the savings rate. At a minimum, this illustrates that the relationship between income taxation and growth may not be as straightforward as the existing literature seems to suggest.