Shifting Taxes from Labor to Consumption: Efficient, But Regressive?

38 Pages Posted: 21 Dec 2013

See all articles by Nico Pestel

Nico Pestel

IZA Institute of Labor Economics

Eric Sommer

IZA Institute of Labor Economics

Abstract

Shifting taxes from labor income to consumption is regularly suggested as a measure to induce work incentives. We investigate the effect of increases in the Value Added Tax on labor supply and the income distribution in Germany, which is compensated by a revenue-neutral reduction in income-related taxes. Based on a dual data base and a microsimulation model of labor supply behavior, we confirm a general regressive impact of such a tax shift in the short run. When accounting for labor supply adjustments, the adverse distributional impact persists for personal income tax reductions, while the overall effects on inequality and progressivity become substantially lower when payroll taxes are reduced, which is due to increased work incentives, especially for low-income households.

Keywords: income and payroll taxes, consumption taxes, microsimulation, labor supply, inequality, Germany

JEL Classification: H21, H23, C63, D31

Suggested Citation

Pestel, Nico and Sommer, Eric, Shifting Taxes from Labor to Consumption: Efficient, But Regressive?. IZA Discussion Paper No. 7804. Available at SSRN: https://ssrn.com/abstract=2370770

Nico Pestel (Contact Author)

IZA Institute of Labor Economics ( email )

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

Eric Sommer

IZA Institute of Labor Economics ( email )

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

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