Consumption Taxes and Economic Efficiency with Idiosyncratic Wage Shocks

Posted: 15 Sep 2005

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)

Abstract

Fundamental tax reform is examined in an overlapping-generations model in which heterogeneous agents face idiosyncratic wage shocks and longevity uncertainty. A progressive income tax is replaced with a flat consumption tax. If idiosyncratic wage shocks are insurable (i.e., no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, wage 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 with Idiosyncratic Wage Shocks. Journal of Political Economy, Vol. 113, pp. 1088-1115, October 2005, Available at SSRN: https://ssrn.com/abstract=799965

Shinichi Nishiyama

Congressional Budget Office ( email )

Ford House Office Building
2nd & D Streets, SW
Washington, DC 20515-6925
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)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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