Simulating U.S. Tax Reform

58 Pages Posted: 25 May 2006  

David Altig

Federal Reserve Banks - Federal Reserve Bank of Atlanta; Federal Reserve Bank of Cleveland; University of Chicago - Booth School of Business

Alan J. Auerbach

University of California, Berkeley - Department of Economics; National Bureau of Economic Research (NBER); CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

Laurence J. Kotlikoff

Boston University - Department of Economics; National Bureau of Economic Research (NBER); Gaidar Institute for Economic Policy

Kent A. Smetters

University of Pennsylvania - Business & Public Policy Department; National Bureau of Economic Research (NBER)

Jan Walliser

Congressional Budget Office

Date Written: October 1997

Abstract

This paper uses a new large-scale dynamic simulation model to compare the equity, efficiency, and macroeconomic effects of five alternative to the current U.S. federal income tax. These reforms are a proportional income tax, a proportional consumption tax, a flat tax, a flat tax with transition relief, and a progressive variant of the flat tax called the 'X tax.' The model incorporates intragenerational heterogeneity and kinked budget constraints. It predicts major macroeconomic gains (including an 11 percent increase in long-run output) from replacing the federal tax system with a proportional consumption tax. Future middle- and upper-income classes gain from this policy, but initial older generations are hurt by the policy's implicit capital levy. Poor members of current and future generations also lose. The The flat tax, which adds a standard deduction to the consumption tax, makes all members of future generations better off, but at a cost of halving the economy's long-run output gain and harming initial older generations. Insulating these older generations through transition relief further reduces transition relief further reduces the long-run gains from tax reform. Switching to a proportional income tax without deductions and exemptions hurts current and future low lifetime earners, but helps everyone else. It also raises long-run output by over 5 percent. The X tax makes everyone better off in the long-run and also raises long-run output by 7.5 percent. But it harms initial older generations who bear its implicit wealth tax.

Suggested Citation

Altig, David and Auerbach, Alan J. and Kotlikoff, Laurence J. and Smetters, Kent A. and Walliser, Jan, Simulating U.S. Tax Reform (October 1997). NBER Working Paper No. w6248. Available at SSRN: https://ssrn.com/abstract=226006

David Altig

Federal Reserve Banks - Federal Reserve Bank of Atlanta

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
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Federal Reserve Bank of Cleveland ( email )

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University of Chicago - Booth School of Business

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Chicago, IL 60637
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Alan Jeffrey Auerbach (Contact Author)

University of California, Berkeley - Department of Economics ( email )

549 Evans Hall #3880
Berkeley, CA 94720-3880
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National Bureau of Economic Research (NBER) ( email )

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CESifo (Center for Economic Studies and Ifo Institute for Economic Research)

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Munich, DE-81679
Germany

Laurence J. Kotlikoff

Boston University - Department of Economics ( email )

270 Bay State Road
Boston, MA 02215
United States
617-353-4002 (Phone)
617-353-4449 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Gaidar Institute for Economic Policy

Gazetny per. 5-3
Moscow, 125993
Russia

Kent Smetters

University of Pennsylvania - Business & Public Policy Department ( email )

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Jan Walliser

Congressional Budget Office ( email )

Ford House Office Building
2nd & D Streets SW
Washington, DC 20515
United States

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