This paper analyzes the e ects of distortionary taxes on growth and welfare in an endogenous growth model with a public capital externality. The model is calibrated to the U.S. economy, and experiments are run under which the tax regime is shifted from the current mix of capital income, labor income, and consumption taxes to a scal policy regime with complete reliance on a single source of taxation, including lump-sum tax. Not surprisingly, we nd that tax policy changes that induce a higher growth rate do not necessarily result in a higher welfare due to di erent transitory e ects. But surprisingly enough, the shift to capital income tax that delivers the highest long-run growth results in the lowest welfare gains. Furthermore, long-run gains take many years { a generation { to start getting realized. Among di erent sources of taxation, we nd that, in the long run, complete reliance on a consumption tax dominates the current tax regime; however, the current tax regime dominates an exclusive labor income tax, which in turn is less welfare-reducing than an exclusive capital income tax. These results are due to the fact that taxes on labor income and capital income distort investment decisions in reproducible capital, i.e., human capital and physical capital, and therefore have cumulative e ects that do not result from a tax on consumption. Unlike previous studies, we account for the welfare e ects of transition using optimal nonlinear decision rules all along the transition path.
Keywords: Endogenous growth, tax policy analysis, welfare, public capital, human capital
JEL Codes: O41, E62, H54
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