Stock Markets, Growth, and Tax Policy



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    • Financial Policy and Systems Division, The World Bank. The views expressed in this paper are solely the responsibility of the author and should not be attributed to The World Bank, its Board of Directors, its management, or any of its member countries. I would like to thank Maria Carkovic, John Coleman, Dale Henderson, Eric Leeper, Giovanna Mossetti, Sergio Rebelo, an anonymous referee, and especially David Gordon for very helpful comments.


An extensive literature documents the role of financial markets in economic development. To help explain this relationship, this paper constructs an endogenous growth model in which a stock market emerges to allocate risk and explores how the stock market alters investment incentives in ways that change steady state growth rates. The paper demonstrates that stock markets accelerate growth by (1) facilitating the ability to trade ownership of firms without disrupting the productive processes occurring within firms and (2) allowing agents to diversify portfolios. Tax policy affects growth directly by altering investment incentives and indirectly by changing the incentives underlying financial contracts.