Externalities are a fundamental aspect of any modern interdependent economy. The fact that agents interact with one another makes it inevitable that their decisions will influence one another directly, in addition to any indirect impact that may occur through the market place. Ever since the earliest stages of the discipline, externalities have been of prime concern to economists, who have long argued that they provide an important motive for (economic) decision making. To cite one prominent example, in The Theory of Moral Sentiments, Adam Smith notes that “Though it is in order to supply the necessities and conveniences of the body that the advantages of external fortune are originally recommended to us, yet we cannot live long in the world without perceiving that the respect of our equals, our credit and rank in the society we live in, depend very much upon the degree in which we possess, or are supposed to possess those advantages. The desire of becoming the proper objects of this respect . . . is perhaps the strongest of all our desires” [Smith (1759, pp. 348–349)]. In modern terminology, Adam Smith is referring to a consumption externality.

We study labor-income and consumption taxation in an overlapping-generations model featuring endogenous growth due to interfirm investment externalities. Consumption, saving, and labor supply display life-cycle features because mortality and labor productivity are age-dependent and because annuity markets may be imperfect. The government's method of revenue recycling critically affects the growth consequences of taxation. Purely consumptive government spending has a negative impact on growth. Redistribution of tax revenue from dissavers to savers may lead to an increase in growth due to beneficial intergenerational transfer effects.

This paper investigates the impact of the desire to keep up with the Joneses (KUJ) on economic growth and optimal tax policy in a continuous-time, overlapping-generations model with AK technology and exogenous, gradual retirement. Due to the desire to KUJ, the propensity to consume out of total wealth rises (declines), and the balanced growth rate declines (increases), when the households' individual total (physical and human) wealth is increasing (decreasing) with age. The rate of retirement determines whether or not a household's total wealth is increasing with age. If total wealth is increasing (decreasing) with age, an optimal allocation is decentralized by an intergenerationally progressive (regressive) lump-sum tax system. The desire to KUJ strengthens the intergenerational regressivity (progressivity) of the optimal tax system. The optimal tax implications of the desire to KUJ are a key finding of this paper.

This paper analyzes the aggregate growth and distributional effects of tax policy using an endogenous growth model with heterogeneous agents having “catching up with the Joneses” (CUJ) types of preferences. We characterize the aggregate equilibrium of this economy, as well as its distributional properties, and show that the consumption externality present with CUJ preferences produces greater income inequality than is obtained with conventional time-separable preferences. The consumption externality substantially alters the effects of tax policy, mostly quantitatively, but in some cases qualitatively as well. Extensive numerical simulations are conducted and used to compare the consequences of different modes of taxation, highlighting the tradeoffs involved.

In this paper we investigate the growth implications of relative wealth preferences in a small open economy model. Domestic capital accumulation, subject to installation costs, is the engine of economic growth in this framework. Crucial in deriving the balanced growth rate is the effective rate of return that arises from agents' status preferences. This results not only in a common balanced growth rate for consumption, the domestic capital stock, and net international financial assets, but also saddle-path dynamics in response to structural shifts. We investigate the short- and long-run dynamics of the model by considering the following standard fiscal shocks: (i) government expenditure, (ii) capital tax, (iii) tax on international financial assets, (iv) consumption tax. Among our results, we find that a permanent fiscal expansion leads to a temporary increase in growth and that a rise in the consumption tax results in a temporary decrease in growth.

This paper studies the growth and fiscal policy implications of the assumption that public policy generates an externality in the individual rate of time preference through the aggregate public capital stock. We examine the competitive equilibrium properties and we solve for endogenous growth–maximizing fiscal policy. We investigate the behavior of the government size and the growth rate to the sensitivity of time preference to public capital and the magnitude of public capital externality on production. We find that the Barro taxation rule [Barro, Robert J., Journal of Political Economy 98 (1990), 103–125], which states that the elasticity of public capital in the production function should equal the government size, is suboptimal. We show that the government does not necessarily have to increase income taxation following a rise in public capital intensity because of the externality of public capital on time preference and, in turn, on growth and the tax base of the economy.

The paper analyzes a multicountry extension of the Barro model of productive public expenditure. In the presence of positive infrastructural externalities between countries, the provision of infrastructure will be inefficiently low if countries do not coordinate. This provides a role for a supranational body, such as the European Union, to coordinate the policies of the individual governments. It is shown how intervention by a supranational body can raise welfare by internalizing the infrastructural externality. Infrastructural externalities increase the importance of tax policy in the growth process and distribute the benefits of taxation across countries.

The DICE (for Dynamic Integrated model of Climate and the Economy) introduced two important policy aspects to the economic discussion of global warming. First, it argues for a “climate-policy ramp” that deems back-loading of mitigation optimal. Second, it demonstrates that an intergenerational tradeoff is at the heart of the mitigation problem. In this paper we argue that both of these findings rest on contestable assumptions. To demonstrate this a recast DICE is presented. Its outcomes show that DICE's predictions are not robust with higher migitations earlier on and slower temperature increases along the optimal path. The adoption of a baseline scenario in which pollution is a negative externality makes mitigating climate change a Pareto improvement. The alleged sacrifice of present generations vanishes. This strengthens the case for immediate policy action.

This paper examines the choice between government expenditure on public goods and transfer payments, in the form of a pension, in an overlapping-generations model. Government expenditure is tax-financed on a pay-as-you-go basis. A utilitarian judge chooses expenditures to maximize a social welfare function. The nonlinear solution is found to involve the ratio of a welfare-weighted average income, which depends on the inequality aversion of the judge, to arithmetic mean income. An approximation for this ratio is found that produces explicit solutions for the optimal composition. The result is used to obtain an indication of “implicit” inequality aversion for a range of countries.