| Productive government expenditures have recently received much attention in the economic growth literature but their financing has only begun to be examined. The latter is of great importance as the choice of government financing can have effects on the overall economy as significant as the expenditures themselves. Only by linking public financing with expenditures can different fiscal policies be analyzed and their effects on aggregates such as consumption, saving, labor supply and GDP be known. This paper creates such a linkage within an optimal growth model by incorporating government rules of allocation . The rules of allocation specify the percentage of particular government revenue sources allocated to specific government expenditures. Government expenditures are divided among transfers, public investment and interest payments on debt while government revenues are divided among debt issues and taxes on consumption and income. Fiscal policies from economists and policy makers are analyzed in this framework and their effects on overall macroeconomic performance and welfare determined. Calibrating the model to the U.S. data for 1999 indicates that higher steady-state welfare could be achieved by eliminating the income tax and funding government expenditures through balanced budget financing with an 18.5% consumption tax. Because approximately 90% of “core infrastructure” is provided by state and local government, the majority of whose funding comes from consumption taxes and debt issues, the usual assumption of financing through a single lump-sum or income tax is shown to be crucial to the growth results. Finally, the model is extended to consider uninformed and informed electorates in which the latter know the government's rules of allocation and behave accordingly while the former lack such information. The uninformed electorate chooses greater consumption and less work today resulting in less steady-state income, consumption, and welfare. The informed electorate, on the other hand, understands where all expenditure is derived and chooses less consumption, more work and greater savings today to receive higher steady-state income, consumption, and welfare. This result suggests recent trends toward greater government budget transparency through capital accounting, user fees, and earmarked funds may bring large welfare benefits to the governed. |
