Growth, Taxes, and Government Expenditures: Growth Hills for U.S. States

Barro-style models of endogenous growth imply that economic growth will initially rise with an increase in taxes directed toward economically "productive" expenditures (e.g., education, highways, public safety), but will subsequently decline—consistent with a "growth hill"—as the rising tax share depresses the net return to private capital. Previous tests focus on whether the linear incremental effect of taxes is positive, negative, or zero, with substantial evidence for all three conclusions. This study incorporates potentially non-monotonic effects for fiscal policy. Based on estimates for U.S. states, the incremental effect of taxes directed toward publicly provided productive inputs is initially positive, but eventually turns negative, consistent with a growth hill.