Taxation, asset bubbles, and endogenous growth

This paper examines the impact of different forms of taxation on economic growth in a model with endogenous technical progress and finitely-lived agents. We find that income taxes lower growth rates (given that income tax revenue is transferred to the old), whereas consumption taxes can, contrary to results usually reported in the literature, even spur growth rates. Therefore, tax reforms aimed to be revenue neutral and growth enhancing should envisage to lower direct taxes while increasing indirect taxes. If there is a bubble in the economy, i.e. a situation where prices of assets differ from their fundamental market values, growth rates are lower since investments are diverted away from productive investments in capital. A capital gains tax, though, limits the size of the bubble and, hence, affects growth rates positively in an economy with an asset bubble. This result is in contrast to economies without asset bubbles, where a capital gains tax usually decreases growth rates.