This paper examines the problem of optimal tax mix analytically in a two-sector growth model with transitional dynamics.
Tax revenue is required to provide a pure public good.
Without investment subsidies, consumption taxes do better than uniform income taxes but they are not Pareto optimal. With subsidies and inelastic leisure, Pareto optimal taxation permits various mixes of consumption and uniform income taxes. Optimal investment subsidy rates always equal income tax rates for both forms of capital, respectively.