Taxation In The Two-Sector Neoclassical Growth Model With Sector-Specific Externalities And Endogenous Labour Supply

This paper examines the long-run impacts of selective (or sector-specific) commodity, payroll, and profit taxes in a two-sector endogenous growth model with sector-specific production externalities, in which one sector produces consumption goods and the other produces investment goods. The novelty of the model is that it allows not only for endogenous labour supply but also for the intersectoral allocation of resources, which may together lead to indeterminacy. We analytically show that the stability properties of the long-run equilibrium critically affect the long-run effects of these selective taxes, which may reverse the standard results of the growth effects of distortionary taxes.