Political Economy of Taxation, Debt Ceilings, and Growth

This study presents an overlapping-generations model with physical and human capital accumulation and considers probabilistic voting over capital and labor taxes and public debt to finance public education expenditure. Our analysis shows that the greater political power of the old induces the government to raise the labor tax on the young and lower the capital tax on the old as well as issue debt. The analysis also shows that the introduction of a debt ceiling rule calls for a rise in the labor tax and thus lowers the welfare of the currently working generation. However, it increases the growth rate, and this growth effect raises the welfare of future generations. These benefits last for a long period even if the rule is imposed only for a limited time.