A key economic issue is whether poor countries or regions tend to grow faster than rich ones: are there automatic forces that lead to convergence over time in the levels of per capita income and product? We use the neoclassical growth model as a framework to study convergence across the 48 contiguous U.S. states. We exploit data on personal income since 1840 and on gross state product since 1963. The U.S. states provide clear evidence of convergence, but the findings can be reconciled quantitatively with the neoclassical model only if diminishing returns to capital set in very slowly. The results for per capita gross domestic product from a broad sample of countries are similar if we hold constant a set of variables that proxy for differences in steady-state characteristics.

The recent literature on endogenous economic growth allows for effects of fiscal policy on long-term growth. If the social rate of return on investment exceeds the private return, then tax policies that encourage investment can raise the growth rate and levels of utility. An excess of the social return over the private return can reflect learning-by-doing with spillover effects, the financing of government consumption purchases with an income tax, and monopoly pricing of new types of capital goods. Tax incentives for investment are not called for if the private rate of return on investment equals the social return. This situation applies in growth models if the accumulation of a broad concept of capital does not entail diminishing returns, or if technological progress appears as an expanding variety of consumer products. In growth models that incorporate public services, the optimal tax policy hinges on the characteristics of the services. If the public services are publicly-provided private goods, which are rival and excludable, or publicly-provided public goods, which are non-rival and non-excludable, then lump-sum taxation is superior to income taxation. Many types of public goods are subject to congestion, and are therefore rival but to some extent non-excludable. In these cases, income taxation works approximately as a user fee and can therefore be superior to lump-sum taxation. In particular, the incentives for investment and growth are too high if taxes are lump sum. We argue that the congestion model applies to a wide array of public expenditures, including transportation facilities, public utilities, courts, and possibly national defence and police.