Quantifying Optimal Growth Policy

This paper develops a comprehensive endogenous growth framework to determine the optimal mix of growth policies. The analysis is novel in that we capture important elements of the tax-transfer system and fully take into account transitional dynamics in our numerical analysis. Currently, for calculating corporate taxable income US firms are allowed to deduct approximately all of their capital and R\&D costs from sales revenue. Our analysis suggests that the status quo policy leads to severe underinvestment in both R\&D and physical capital. We find that firms should be allowed to deduct between 2-2.5 times their R\&D costs and about 1.5-1.7 times their capital costs from sales revenue. Implementing the optimal policy mix is likely to entail huge welfare gains.