Working Paper: NBER ID: w9492
Authors: Shinichi Nishiyama; Kent Smetters
Abstract: Fundamental tax reform is examined in a heterogeneous overlapping-generations (OLG) model in which agents face idiosyncratic earnings shocks and uncertain life spans. Following Auerbach and Kotlikoff (1987), a Lump-Sum Redistribution Authority is used to rigorously examine efficiency gains over the transition path. A progressive income tax is replaced with a flat consumption tax (for example, a value-added tax or a national retail sales tax). If shocks are insurable (that is, no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, shocks are uninsurable, this reform reduces efficiency, even though national wealth and output increase over the entire transition path. This efficiency loss, in large part, stems from reduced intragenerational risk sharing that was previously provided by the progressive tax system
Keywords: Consumption Taxes; Economic Efficiency; Stochastic OLG Model
JEL Codes: H0; H2; H3
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| idiosyncratic earnings shocks are insurable (G52) | transition from a progressive income tax to a flat consumption tax improves interim efficiency (H21) |
| idiosyncratic earnings shocks are uninsurable (D89) | transition from a progressive income tax to a flat consumption tax leads to a reduction in efficiency (H21) |
| transition from a progressive income tax to a flat consumption tax (H29) | decline in intragenerational risk sharing (D15) |
| transition from a progressive income tax to a flat consumption tax (H29) | reduction in efficiency (D61) |
| progressive tax system (H29) | facilitates intragenerational risk sharing (D15) |
| Ramsey model (C59) | simplifies analysis of efficiency changes (D61) |
| Ramsey model (C59) | fails to capture risk-sharing benefits of progressive system (P43) |