Is a Flat Tax Politically Feasible in a Grown-Up Welfare State?

FiFo-CPE Discussion Paper No. 07-6

25 Pages Posted: 19 Jun 2007

See all articles by Clemens Fuest

Clemens Fuest

ifo Institute – Leibniz Institute for Economic Research at the University of Munich; Ludwig-Maximilians-University, Munich; Center for Economic Studies (CES)

Andreas Peichl

ZEW – Leibniz Centre for European Economic Research; University of Mannheim - School of Economics (VWL); IZA Institute of Labor Economics; University of Essex - Institute for Social and Economic Research (ISER)

Thilo Schaefer

Institut der deutschen Wirtschaft Köln

Date Written: May 23, 2007

Abstract

The introduction of a flat tax is supposed to have several advantages. Administration and compliance costs are reduced, as well as incentives for tax evasion. Furthermore, positive employment and growth effects are expected. Despite these advantages, a flat rate tax is not very popular in most Western European countries. The most important objection against a flat tax states that a flat rate tax would be inequitable and unfair. The present paper uses a simulation model based on a unique database of German micro data to provide empirical evidence for the analysis of the equity and efficiency effects as indicators for the political feasibility of flat rate tax reforms. Our analysis shows that the selection of the schedule and tax base parameters are crucial for the effects of flat tax reforms in terms of equity and efficiency. A flat rate tax with a higher basic allowance and a higher single rate has less harmful distributional effects than a flat rate tax with low basic allowance and tax rate. Nevertheless, the scenario with the lowest parameter values for basic allowance and tax rate is the only alternative that leads to positive labour supply and significantly positive welfare effects. Both labour supply and static welfare effects, however, are quite small. Although we have derived our results for the case of Germany, we do think that similar patterns would be observed in other countries of Western Europe. If this proves to be correct, it will be hard for flat tax reforms to invade the grown-up welfare states of Old Europe.

Keywords: flat tax reform, equity, efficiency, distribution, welfare

JEL Classification: D31, D60, H20

Suggested Citation

Fuest, Clemens and Peichl, Andreas and Schaefer, Thilo, Is a Flat Tax Politically Feasible in a Grown-Up Welfare State? (May 23, 2007). Available at SSRN: https://ssrn.com/abstract=995174 or http://dx.doi.org/10.2139/ssrn.995174

Clemens Fuest (Contact Author)

ifo Institute – Leibniz Institute for Economic Research at the University of Munich

Poschinger Str. 5
Munich, DE 81679
Germany
++89-9224-1430 (Phone)

Ludwig-Maximilians-University, Munich ( email )

Schackstrasse 4 / II
Munich, DE 80539
Germany

Center for Economic Studies (CES) ( email )

Schackstr. 4
Munich, DE 80539
Germany
++89 2180-2748 (Phone)
++89 2180-17845 (Fax)

Andreas Peichl

ZEW – Leibniz Centre for European Economic Research ( email )

P.O. Box 10 34 43
L 7,1
D-68034 Mannheim, 68034
Germany

University of Mannheim - School of Economics (VWL) ( email )

Mannheim 68131
Germany

IZA Institute of Labor Economics ( email )

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

University of Essex - Institute for Social and Economic Research (ISER)

Wivenhoe Park
Colchester CO4 3SQ
United Kingdom

Thilo Schaefer

Institut der deutschen Wirtschaft Köln ( email )

50668 Koeln
Germany

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