Growth, income inequality and fiscal policy: What are the relevant tradeoffs

We develop an endogenous growth model with elastic labor supply, in which agents differ in their initial endowments of physical capital. In this context, the growth rate and the distribution of income are jointly determined. We then examine the distributional impact of different ways of financing an investment subsidy. We find that policies aimed at increasing the growth rate tend to result in a more unequal distribution of pre-tax income, consistent with the positive correlation between income inequality and growth observed in the recent empirical literature. However, there seems to be no conflict between efficiency and equity if inequality is measured in terms of the distribution of welfare. JEL Classification: E62, O17, O40