Normative Fiscal Policy and Growth: Some Quantitative Implications for the Chilean Economy

This paper explores the qualitative and quantitative implications of optimal tax- ation in a developing economy when economic growth is endogenously determined. We di¤erentiate this class of economies from a developed economy in two aspects: 1. the informal sector is quantitatively signi…cant and, 2. tax-collecting technologies are more rudimentary. We characterize competitive equilibrium allocations and Ramsey allocations in the context of a small open economy in which the interest rate is endoge- nously determined, some workers can be hired in the informal market and imperfect tax-collecting technology can be heterogeneous across types of taxes. We calibrate the parameters of our model to the Chilean economy. Overall, our results suggest that capital should still be taxed but considerably less than actual taxes (that is, 10.78% versus 18.5%). Labor should be subsidized (to stimulate accumulation of human capital) while consumption taxes should be increased by 50% approximately (from 19% to 28%). As expected, the better collecting technologies, the higher the corresponding taxes. In this context, the resulting growth rate increases only slightly along the balanced growth path.