Innovation dynamics and fiscal policy: Implications for growth, asset prices, and welfare

We study the equilibrium implications of different fiscal policies on macroeconomic quantities and welfare by utilizing an endogenous growth model that matches asset pricing data well. The fiscal instruments of interest are (i) subsidies to R&D expenditure, consumption and capital investment, and (ii) cuts in labor and corporate tax rates. Our equilibrium analysis provides new insights on the interplay of innovation dynamics and fiscal policy. Importantly, we find growth and welfare to be inversely related when changing R&D subsidies. However, this depends on how well the model reproduces asset pricing dynamics. Moreover, only subsidies to capital investments and cuts in the corporate tax rate have the potential to increase both growth and welfare. •Analysis of fiscal policy changes in stochastic endogenous growth models.•Fiscal policy: subsidies to consumption, capital investment, and R&D investments.•Effects of changes in entrant R&D subsidies differ across parameterizations.•Growth and welfare are found to be inversely related when changing R&D subsidies.•Investment subsidies and corporate tax cuts increase both growth and welfare.