Taxation, human capital formation, and long-run growth with private investment in education

By extending a long-run endogenous growth model to include (i) both public and private investments in human capital formation and (ii) endogenous population growth, this paper examines the growth effects of Indonesian government policy that lowered the capital income tax rate in the mid-1980s. Quantitative analysis of the model finds that the introduction of these two features not only makes economic growth more sensitive to changes in capital income taxation than in models that omit these features, but also produces a relatively high growth rate as observed in the data. Moreover, results show that the growth effects of changes in public spending on education are stronger than those of taxation. This suggests that in the endogenous growth model, public policy aimed at enhancing human capital is more conducive to growth than a physical investment-encouraging tax reform.