Flat Tax Reform: A Quantitative Exploration

Abstract

This paper explores quantitatively the general equilibrium implications of a revenue neutral tax reform, in which the current income and capital income tax structure in the U.S. is replaced by a flat tax, as proposed by Hall and Rabushka (1995). The central aspects of such reform, the impact of tax reform on capital accumulation, labor supply and welfare, as well as its distributional consequences, are analyzed in a dynamic general equilibrium model where key features of the actual tax code are modeled. The main results are that 1) the elimination of the actual double taxation of capital income has an important positive effect on capital accumulation; 2) aggregate labor hours decrease in all the cases considered; 3) in all circumstances analyzed, the distributions of earnings, income, and particularly wealth become more concentrated; 4) in some particular cases, despite large aggregate welfare gains, not all households benefit from tax reform.

JEL Classification: E62, H20