Dynamic Scoring through Creative Destruction

Abstract

We examine the dynamic feedback effects of fiscal policies on the government budget and economy activity in a calibrated general equilibrium framework featuring endogenous growth through creative destruction. For several European countries, we find that making tax incentives with respect to research effort more generous is the least costly way, in terms of the impact on the government budget, to promote economic growth. It is almost three times as cost effective as lowering the tax rate on capital income. When non-distorting financing options are excluded, adjusting the consumption tax to finance more generous tax incentives for research effort leads to the smallest loss in economic efficiency and the largest welfare gain.