Efficiency and distribution effects of a revenue-neutral income tax reform

• Published in: Journal of macroeconomics Vol. 25; no. 1; pp. 87 - 107
• Main Authors: Heer, Burkhard, Trede, Mark
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier Inc 01.03.2003; Elsevier; Elsevier Science Ltd
• Series: Journal of Macroeconomics
• Subjects: Consumption; Consumption taxation; Consumption taxes; Economic models; Economic theory; Efficiency; Flat rates; Flat-rate tax; Income distribution; Income tax; Income taxation; Income taxes; Macroeconomics; Studies; Tax reform; Taxation; Germany; E62; Income distribution; D33; H23; H24; Income taxation; Consumption taxation; Flat-rate tax
• ISSN: 0164-0704; 1873-152X
• DOI: 10.1016/S0164-0704(03)00008-9

We study the quantitative effects of two revenue-neutral income tax reform proposals, (i) a flat-rate tax and (ii) a consumption tax, in a general equilibrium model with elastic labor supply and progressive income taxation. Households are heterogeneous with regard to their productivity and their assets. The model is calibrated with regard to the German economy in 1996. Importantly, the endogenous labor income distribution as computed from our model is equal to the empirical labor income distribution in Germany. As our first main result, both reform proposals are shown to have only negligible effects on the labor income distribution. Second, both tax reform proposals result in a moderate increase of aggregate employment and a strong increase of aggregate savings. And third, both reform proposals imply significant steady-state welfare gains equivalent to a rise of total consumption of 3.6% and 8.2%, respectively.