Is a Flat Tax Feasible in a Grown-up Welfare State?

24 Pages Posted: 26 Nov 2007

See all articles by Clemens Fuest

Clemens Fuest

ifo Institute – Leibniz Institute for Economic Research at the University of Munich; Ludwig-Maximilians-University, Munich; Center for Economic Studies (CES)

Andreas Peichl

ZEW – Leibniz Centre for European Economic Research; University of Mannheim - School of Economics (VWL); IZA Institute of Labor Economics; University of Essex - Institute for Social and Economic Research (ISER)

Thilo Schaefer

Institut der deutschen Wirtschaft Köln

Date Written: November 2007

Abstract

The success of the flat rate tax in Eastern Europe suggests that this concept could also be a model for the welfare states of Western Europe. The present paper uses a simulation model to analyse the effects of revenue neutral flat rate tax reforms on equity and efficiency for the case of Germany. We find that a flat rate tax with a low tax rate and a low basic allowance yields positive static welfare effects amounting to approximately 1.8 per cent of income tax revenue but increases income inequality. The increase in income inequality can be avoided by combining a higher tax rate with a higher basic allowance. But in this case the efficiency gains vanish. We conclude that, due to their limited efficiency effects and their problematic distributional impact, flat tax reforms are unlikely to spill over to the welfare states of Western Europe.

Keywords: flat tax reform, equity, efficiency, distribution, welfare

JEL Classification: D31, D60, H20

Suggested Citation

Fuest, Clemens and Peichl, Andreas and Schaefer, Thilo, Is a Flat Tax Feasible in a Grown-up Welfare State? (November 2007). IZA Discussion Paper No. 3142. Available at SSRN: https://ssrn.com/abstract=1032578

Clemens Fuest (Contact Author)

ifo Institute – Leibniz Institute for Economic Research at the University of Munich

Poschinger Str. 5
Munich, DE 81679
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Ludwig-Maximilians-University, Munich ( email )

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Center for Economic Studies (CES) ( email )

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Andreas Peichl

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
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D-68034 Mannheim, 68034
Germany

University of Mannheim - School of Economics (VWL) ( email )

Mannheim 68131
Germany

IZA Institute of Labor Economics ( email )

P.O. Box 7240
Bonn, D-53072
Germany

University of Essex - Institute for Social and Economic Research (ISER)

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

Thilo Schaefer

Institut der deutschen Wirtschaft Köln ( email )

50668 Koeln
Germany

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