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R&D subsidies, income taxes, and growth through cycles

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Abstract

In growth-cycle models, consumption smoothing motivates procyclical household savings and monopolistic competition engenders countercyclical horizontal R&D at fixed costs of capital. However, data in the US and in 15 OECD countries indicate countercyclical household saving, procyclical R&D, and high volatility. This paper explains the observed cyclical properties by realistic income taxes, R&D subsidies, R&D labor, and depreciation. R&D subsidies promote R&D to increase productivity by trading the levels for the varieties of intermediates. R&D-subsidy payments increase consumption and decrease household saving rates by raising taxable income beyond output, thus hindering future R&D and growth. Anticipated R&D-subsidy payments increase household-saving rates by raising returns to saving, thus promoting future R&D and growth. The US taxes yield unstable fluctuations with consecutive periods of R&D, low saving rates, and strong growth as in the technology boom. R&D labor and partial depreciation strengthen the roles of saving and R&D in attaining high volatility.

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Acknowledgements

The authors would like to thank Editor Nicholas Yannelis, an anonymous Associate Editor, and two anonymous reviewers for their valuable comments and suggestions. Wan gratefully acknowledges the financial support from the National Social Science Fund of China (Grant No. 22BJL021). The usual disclaimer applies.

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Authors and Affiliations

  1. College of Management and Economics, Tianjin University, Tianjin, China

    Jing Wan

  2. School of Economics and Business Administration, Chongqing University, Chongqing, China

    Jie Zhang

  3. Department of Economics, National University of Singapore, Singapore, Singapore

    Jie Zhang

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Wan, J., Zhang, J. R&D subsidies, income taxes, and growth through cycles. Econ Theory 76, 827–866 (2023). https://doi.org/10.1007/s00199-022-01480-y

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