Welfare and fiscal policy with public goods and infrastructure

Abstract

We construct and simulate a model to study the welfare and macroeconomic impact of government actions when its productive role is taken into account. The trade-off between public investment and public consumption is also investigated, since public consumption is introduced as a public good that directly affects individuals' well-being. Our results replicate econometric evidence showing that part of the observed slowdown of U.S. productivity growth can be explained by the reduction of investment in infrastructure, which also implied a sizable welfare loss to the population. Depending on the methodology used we found a welfare cost ranging from 4.2% to 1.16% of GNP. The impact of fiscal policy can be qualitative and quantitative distinct depending on whether we assume a higher or smaller output-elasticity to infrastructure. If it is high enough, increases in tax rates may stimulate accumulation and production, which is the opposite prediction of standard neoclassical models.