Do Taxes Matter for Long-Run Growth? Harberger's Superneutrality ConjectureWP/95/79-EA Do Taxes Matter for Long-Run Growth? Harberger's Superneutrality Conjecture by Enrique G. Mendoza, Gian Maria Milesi-Ferretti and Patrick Asea The question of how changes in tax policy affect economic activity and welfare is a central one in macroeconomics and public finance. Arnold Harberger, a leading contributor to the literature on this question, conjectured that, although the mix of direct and indirect taxes affects investment and growth in theory, growth effects of taxation are negligible in practice. This paper re-examines theoretically and empirically the relations between tax policy, investment, and growth; it provides evidence in support of Harberger's view by testing the predictions of endogenous growth models driven by human capital accumulation. The theoretical analysis presents a standard two-sector model of endogenous growth, highlighting the effects of factor income and consumption taxes on growth and investment. In particular, the analysis shows that the effects of taxation on economic activity depend crucially on the elasticity of labor supply and the tax treatment of the sector producing human capital. The empirical work in this paper is based on cross-country regressions and numerical simulations, using a new methodology for estimating aggregate effective tax rates developed in Mendoza, Razin, and Tesar (1994). Results using panel regressions based on five-year averages and annual data show significant investment effects from income and consumption taxes. In particular, higher tax rates on capital and labor income are associated with lower private investment levels, while higher consumption taxes result in higher private investment levels. The growth effects of taxes are, however, small. Furthermore, they are statistically significant only in full-panel regressions, when the time-series dimension of the data is fully considered. These results are robust to the introduction of other growth determinants. |