Regulation, Taxation, and Economic Development

In this paper we construct a model with increasing returns stemming from product variety to explore the different effects of regulations and taxes on economic development, real activity, and growth. Regulations raise fixed and variable costs, while taxes primarily increase variable costs. This is important because fixed costs determine the extent of specialization, which in our model plays an important role in human capital accumulation and development. Given the choice, taxation is preferred to regulation, because of regulation's negative effects on the growth of human capital. Empirical tests using panel data across countries provide support for the theory. (JEL Codes: O41, O33, O14, E24, E23)