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A Note on the Optimality of the Cash Flow Tax

Keywords: endogenous growth, optimal taxing, cash ‡ow.

This paper analyzes the optimal tax policy within an endoge-nous growth model with productive government spending. We consider a one-factor (human capital) one-good economy, with the latter serving both as a final and an intermediate good. The government levies taxes in order to finance the provision of the intermediate good. Within this framework we show a highly intuitive result: the optimal tax structure is a 100 percent tax on cash flows and no tax on labor income. As a consequence, the consumption tax causes a deadweight loss, which increases with the intensity of use of the intermediate good.