Fiscal policy, elastic labor supply, and endogenous growth

Endogenizing labor supply leads to fundamental changes in the equilibrium structure of the AK growth model. The balanced growth equilibrium can be described in terms of two tradeoff loci relating the equilibrium growth rate to the fraction of time devoted to leisure. The implications of endogenous labor supply for fiscal policy are analyzed. Three issues are addressed. First, the effects of various distortionary tax changes and government expenditure changes on the equilibrium growth-leisure (employment) tradeoff are analyzed. Second, optimal fiscal policy is characterized. Finally, the formal analysis is supplemented by numerical results, focusing particularly on the quantitative welfare implications. (C) 2000 Elsevier Science B.V. All rights reserved. JEL classification: E62; J22; O41.