Shifting Taxes from Labor to Consumption: More Employment and More Inequality?

22 Pages Posted: 28 Aug 2017

See all articles by Nico Pestel

Nico Pestel

IZA Institute of Labor Economics

Eric Sommer

IZA Institute of Labor Economics

Date Written: September 2017

Abstract

This paper investigates the effect of shifting taxes from labor income to consumption on labor supply and the distribution of income in Germany. We simulate stepwise increases in the value‐added tax (VAT) rate, which are compensated by revenue‐neutral reductions in income‐related taxes. We differentiate between the personal income tax (PIT) and social security contributions (SSC). Based on a dual data base and a microsimulation model of household labor supply behavior, we find a regressive impact of such a tax shift in the short run. When accounting for labor supply adjustments, the adverse distributional impact persists for PIT reductions, while the overall effects on inequality and progressivity become lower when payroll taxes are reduced. This is partly due to increases in aggregate labor supply, resulting from higher work incentives.

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

JEL Classification: C63, D31, H23

Suggested Citation

Pestel, Nico and Sommer, Eric, Shifting Taxes from Labor to Consumption: More Employment and More Inequality? (September 2017). Review of Income and Wealth, Vol. 63, Issue 3, pp. 542-563, 2017. Available at SSRN: https://ssrn.com/abstract=3026855 or http://dx.doi.org/10.1111/roiw.12232

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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