Public capital, endogenous growth, and tax concession on savings
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Public capital, endogenous growth, and tax concession on savings Manash Ranjan Gupta1
© Editorial Office, Indian Economic Review 2020
Abstract An endogenous growth model is developed where, on one hand income tax revenue is utilized to finance investment on public capital, and on the other hand tax concession is given on savings. If one of the two instruments—proportional income tax rate and proportional tax-concession rate on savings—is used as the policy variable to maximize the balanced growth rate while the other is treated as a parameter, an exogenous increase in the value of the parameter raises the optimum value of the policy variable and generates a positive effect on endogenous growth rate as well as on the rate of savings in the steady-state equilibrium. Keywords Endogenous growth · Public capital · Steady-state equilibrium · Savings · Proportional · Lump sum · Income tax · Tax concession · Optimum JEL Classification H20 · O41
1 Introduction Private capital accumulation is an important source of economic growth and is mainly financed through savings. Public capital accumulation is another important source of economic growth and is mainly financed by tax revenue of the government. Taxes on income are an important source of tax revenue. The income tax policy of the government is often accompanied by a policy of tax concessions on savings. To understand tax concession on savings we can consider the following example. If income is INR 100,000 and tax rate is 30%, the individual pays INR 30,000 as tax. Her disposable income is INR 70,000 out of which she saves INR 20,000. If the tax exemption rate on savings is 10% then she gets a refund of INR 2000. Therefore, the tax revenue of the government is reduced to INR 28,000 and * Manash Ranjan Gupta [email protected]; [email protected] 1
Economic Research Unit, Indian Statistical Institute, 203, B. T. Road, Kolkata, West Bengal 700108, India
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the disposable income of the tax payer goes up to INR 72,000. This increase in disposable income has a positive effect on household savings if the marginal propensity to save is positive. Thus, a policy of income tax concession on savings is expected to raise the level of household savings but reduce government revenue leading to a fall in the volume of productive public infrastructure. An interesting research question is how this tax-concession policy affects private investment economic growth and the optimum tax rate. One can also investigate whether the government can solve for the optimum tax rate and the optimum taxconcession rate simultaneously and how the two are related to each other. In this paper we want to find the answer using an endogenous growth model where productive public expenditure generates endogenous growth and where the proportional income tax is accompanied by a tax-concession on savings. In reality, the research question mentioned above is important because in many countries governments provide income tax concession on savings. There is empirical
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