Department of Applied Economics II, University of A Coruña, Campus de Elviña, 15071 A Coruña, Spain
Copyright © 2010 Manuel A. Gómez. This is an open access article distributed under the
Creative Commons Attribution License, which permits unrestricted use, distribution, and reproduction in any medium, provided the original work is properly cited.
This paper introduces habit-forming preferences in a Barro-type endogenous growth model with productive public services. Government
expenditure, which may be subject to congestion, is financed by distortionary income taxation. Different from the standard time-separable model,
the presence of habits makes the economy feature transitional dynamics, which are solved in closed form. Setting the income tax so as to equate
the elasticity of public services in production is shown to maximize both long-run growth and welfare as in the standard model. This second-best solution coincides with the first-best outcome only in the presence of proportional congestion.