Proposals for fundamental reform of the federal tax code are receiving increased attention in the business press and among economic analysts and policymakers. President Bush has identified tax reform as a top priority, calling for a tax system that is “pro-growth, easy to understand, and fair to all.” Moreover, the President has appointed a commission to consider different approaches to tax reform. One approach might be to improve the current income-based federal tax code, perhaps by broadening the tax base and lowering income-tax rates. However, another approach might be to replace current income taxes altogether with a consumption tax. Switching the federal tax system from an income tax to a consumption tax could have important macroeconomic effects. Most economists believe that switching to a consumption tax could increase saving and real output per person over the long run, although studies differ on the size of these effects. However, switching to a consumption tax might also require sizable short-run economic adjustments and create challenges for monetary policymakers. Garner analyzes the macroeconomic effects of replacing the current federal tax system with a consumption tax. First, he provides some background on the goals of tax reform and the basic difference between an income tax and a consumption tax. Next, he describes three widely discussed versions of a consumption tax: a national retail sales tax, a value-added tax, and a consumption-type flat tax. Finally, he examines the macroeconomic effects of adopting a consumption tax. All three proposals could raise U.S. output over the long run, but adopting a consumption tax could have sizable transition effects as well. These transition effects could vary depending on which consumption tax was adopted and how monetary policy responded to the reforms.
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Article provided by Federal Reserve Bank of Kansas City in its journal Economic Review.
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David F. Bradford, 2003.
"The X Tax in the World Economy,"
Working Papers
109, Princeton University, Department of Economics, Center for Economic Policy Studies..
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