Journal of Economics and Business 54 (2002) 651654

A note on government spending on infrastructure in an

endogenous growth model with nite horizon
Jumpei Tanaka

Graduate School of Economics, Kobe University, Nada-ku, Kobe 657-8501, Japan

Received 10 September 2001; received in revised form 3 April 2002; accepted 29 April 2002
Abstract
By extending the work of Mourmouras and Lee (1999), we show that the growth-maximizing income
tax rate maximizes also the utilities of not only all current generations but also all future generations. This
result means that the statement that the growth-maximizing income tax rate is equivalent to the welfare
maximizing one holds true in a stronger sense than Barro (1990) and Mourmouras and Lee (1999) have
pointed out.
2002 Elsevier Science Inc. All rights reserved.
JEL classication: E62; H54
Keywords: Overlapping generations; Endogenous growth; Productive government spending
1. Introduction
In a seminal article, Barro (1990) constructed a simple endogenous growth model with pro-
ductive government expenditures, and showed that the growth-maximizing income tax rate
is equivalent to the welfare-maximizing one. However, since he employed a representative
agent model, it is not clear how the growth-maximizing tax rate affects the welfare of each
generation. If the growth-maximizing rate is not optimal for some generations, it is not nec-
essarily desirable for the government to adopt that rate. Thus, it is worth investigating this
issue by extending Barros discussion to the framework of an overlapping generations model.
Recently, Mourmouras and Lee (1999) tackled this problem by combining Barros model with

Present address: 1-8-30 Suzaku, Nara 631-0806, Japan. Tel.: +81-742-71-6167.

E-mail address: 981d207e@yku.kobe-u.ac.jp (J. Tanaka).
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652 J. Tanaka / Journal of Economics and Business 54 (2002) 651654
a Blanchard-type overlapping generations model, and derived a number of interesting results,
one of which is that the growth-maximizing level of public investment maximizes also the
utility of the currently lived representative cohort. In their analysis, however, only the wel-
fare effect on the representative current generation is considered, and the welfare effect on
future generations is not examined. So in this note we extends their analysis, and demonstrate
that the growth-maximizing income tax rate maximizes also the utilities of not only all cur-
rent generations but also all future generations. This result means that the statement that the
growth-maximizing income tax rate is equivalent to the welfare-maximizing one holds true in
a stronger sense than Barro (1990) and Mourmouras and Lee (1999) have pointed out.
2. Model and analysis
The model we consider is the same as that of Mourmouras and Lee (1999), so the reader
should refer to it for notations and detailed derivations. The aggregate dynamic equations are
summarized as follows:

C(t ) = [(1 )(1 )

/1
]C(t ) ( +)K(t ) (1a)

K(t ) = [(1 )
/1
]K(t ) C(t ). (1b)
Since this model is a simple AK-type growth model, the economy is always on the balanced
growth path. After some manipulations the growth rate n of this economy can be derived as
2n = (2 )x 2

(x +)
2
+4( +), where x (1 )
/1
. (2)
First, we conrm that the growth-maximizing income tax rate is given by the Barro rule, that
is, the elasticity of output Y with respect to the productive government spending G. This has
already been pointed out by Mourmouras and Lee, but their result is derived fromthe numerical
analysis, so it is worth conrming this analytically. Differentiating (2) with respect to , we
have
2
n

=
x

, where (2 ) (x +)[(x +)
2
+4( +)]
1/2
> 0.
(3)
Accordingly, maximizing n is equivalent to maximizing x, and the growth-maximizing income
tax rate is = .
Second, we investigate the welfare implication of the growth-maximizing tax. Suppose that
the economy is at time t. The indirect utility functions of cohort s (s t : the current generations;
s > t : the future generations) are given by
U

(s, t ) =
log[a(s, t ) +(1 )h(t )]
+
+
(1 )x
( +)
2
+const (4a)
U

(s, s) =
log[(1 )h(s)]
+
+
(1 )x
( +)
2
+const (4b)
where h(t )
/1
K(t )/[(1 )x + n] and const log( +)/( +).
J. Tanaka / Journal of Economics and Business 54 (2002) 651654 653
Note that U

(s, s) is measured at time s because cohort s (>t) is not born at time t. Since the
welfare effect of the growth-maximizing tax on current cohorts has already been discussed by
Mourmouras and Lee, we focus on the effect on future generations. Differentiating (4b) with
respect to , we have
U

(s, s)

=( +)
1

log

xK(t )
(1 )x + n

+
s t
+
n

+
1
( +)
2
x

. (5)
From (5) we can see that a change in the tax rate affects the welfare through three channels.
The rst term of the RHS of (5) represents the total wealth effect, which means the variation in
both human and non-human wealth. Note that only the variation in human wealth appears in (5)
because cohort s (>t) has no non-human assets at time s. The second term represents the capital
growth effect. Higher level of capital stock at time t corresponds to higher real wage which is
paid to cohort s (>t) when she is born. This second effect is characteristic to future generations.
The third term represents the consumption growth effect. Higher rate of consumption growth
corresponds to higher level of individual welfare. Arranging (5), we have
U

(s, s)

=
future

(for s > t ) (6)

where

future

(/2)x + n
x[(1 )x + n]
+
(/2)(s t )
+
+
1
( +)
2
) > 0.
Eq. (6) means that the tax rate which maximizes the utilities of all future generations is = ,
the growth-maximizing tax rate. We can apply the same procedure for current generations and
can obtain the same result. Hence, it has been proved that the growth-maximizing income tax
rate maximizes also the utilities of all current and future generations.
1
3. Conclusion
In this note we extended the analysis of Mourmouras and Lee (1999), and demonstrated
that the growth-maximizing income tax rate maximizes also the utilities of not only all current
generations but also all future generations. This result seems important because this means that
changing the income tax rate according to the Barro rule is a Pareto-improving policy.
Note
1. In the analysis above, the instantaneous utility function of each household is assumed to
be logarithmic, but we can show that using a CRRA utility function does not alter our
result.
654 J. Tanaka / Journal of Economics and Business 54 (2002) 651654
Acknowledgments
I am grateful to Kenneth J. Kopecky, Donald H. Dutkowsky and an anonymous referee for
helpful suggestion on an earlier version of this paper. I also thank H. Adachi, K. Mino, N.
Nakanishi, K. Futagami and seminar participants at Adachi OB meeting for useful comments
and discussions. I am responsible for any remaining errors.
References
Barro, R. J. (1990). Government spending in a simple endogenous growth model. Journal of Political Economy,
98(3), S103S125.
Mourmouras, I. A., & Lee, J. E. (1999). Government spending on infrastructure in an endogenous growth model
with nite horizon. Journal of Economics and Business, 51, 395407.