Optimal Composition of Government Public Capital Financing

Abstract

Most recent studies on growth models with public investment in infrastructure (public capital) presume that public capital is financed by income taxation. However, in the model where money is demanded for transactions, this paper finds that optimal public capital financing in general involves utilizing both income taxation and seigniorage. In such a case, the optimal income tax rate is less than the output elasticity of public capital, a reasonable result compared with empirical evidence.