Optimal Fiscal Rules for Green Growth in an Endogenous Growth Model: An Analytical Derivation

To explore the effects of a tighter environmental policy on long-run sustained growth, this paper uses a one-sector dynamic model of endogenous growth, based on the joint accumulation of private capital and abatement knowledge capital. It then derives analytically the optimal fiscal rules on public investment and taxation for ‘green growth' defined as ecologically-sustainable development). The result implies that the long-run sustained balanced-growth path and the effects of some tightening environmental and fiscal policy depend crucially on some key parameters of the economy such as production elasticity of abatement knowledge and the difference between the productivities of abatement knowledge and pollution in production. Moreover, unlike the previous results suggested by the literature on growth and taxation, the rate of environmental investment that maximizes the long-run growth rate should be greater than its own ‘pure’ output elasticity by the amount of the premium for environmental sustainability. Thus, for green growth, it is shown that the overall abatement knowledge intensity of production in the economy should be directed by this fiscal rule.