Consumption Taxes and Economic Efficiency in a Stochastic OLG Economy

58 Pages Posted: 13 Feb 2003 Last revised: 9 Oct 2009

See all articles by Shinichi Nishiyama

Shinichi Nishiyama

Congressional Budget Office

Kent A. Smetters

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

Date Written: February 2003

Abstract

Fundamental tax reform is examined in a heterogeneous overlapping-generations (OLG) model in which agents face idiosyncratic earnings shocks and uncertain life spans. Following Auerbach and Kotlikoff (1987), a Lump-Sum Redistribution Authority is used to rigorously examine efficiency gains over the transition path. A progressive income tax is replaced with a flat consumption tax (for example, a value-added tax or a national retail sales tax). If shocks are insurable (that is, no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, shocks are uninsurable, this reform reduces efficiency, even though national wealth and output increase over the entire transition path. This efficiency loss, in large part, stems from reduced intragenerational risk sharing that was previously provided by the progressive tax system

Suggested Citation

Nishiyama, Shinichi and Smetters, Kent, Consumption Taxes and Economic Efficiency in a Stochastic OLG Economy (February 2003). NBER Working Paper No. w9492, Available at SSRN: https://ssrn.com/abstract=379981

Shinichi Nishiyama

Congressional Budget Office ( email )

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United States

Kent Smetters (Contact Author)

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

3641 Locust Walk
Philadelphia, PA 19104-6372
United States

National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
United States

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