This paper investigates the impact of public expenditures and taxation on economic growth using panel data for a sample of OECD countries. The empirical results suggest that fiscal policy influences growth through three main channels. First, the government contributes directly to factor accumulation through public investment in infrastructure and other assets. Second, public expenditure tends to crowd out private investment by reducing disposable income and the incentive to save. Third, there is evidence of a sizeable negative ‘externality’ effect of government on the level of productivity. According to the estimates, the effective cost of $1 of public expenditure is around $1.3 once the relevant distortions are taken into account. While this figure is viewed as an upper bound, it does suggest that taxes and public expenditures generate significant efficiency costs which should be taken into account when making budget decisions.
