The efficiency and welfare effects of tax reform: are fewer tax brackets better than more?
AbstractUsing the well-known dynamic fiscal policy framework pioneered by Auerbach and Kotlikoff, we examine the efficiency and welfare implications of shifting from a linear marginal tax rate structure to a discrete rate structure characterized by two regions of flat tax rates of 15 and 28 percent. For a wide range of parameter values, we find that there is no sequence of lump-sum transfers that the (model) government can feasibly implement to make the shift from the linear to the discrete structure Pareto-improving. We conclude that the worldwide trend toward replacing rate structures having many small steps between tax rates with structures characterized by just a few large jumps is not easily accounted for by efficiency arguments. In the process of our analysis, we introduce a simple algorithm for solving dynamic fiscal policy models that include "kinks" in individual budget surfaces due to discrete tax codes. In addition to providing a relatively straightforward way of extending Auerbach-Kotlikoff-type models to this class of problems, our approach has the side benefit of facilitating the interpretation of our results.
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Bibliographic InfoPaper provided by Federal Reserve Bank of Cleveland in its series Working Paper with number 9212.
Date of creation: 1992
Date of revision:
Other versions of this item:
- David Altig & Charles T. Carlstrom, 1994. "The efficiency and welfare effects of tax reform: are fewer tax brackets better than more?," Economic Review, Federal Reserve Bank of Cleveland, issue Q IV, pages 30-42.
- David Altig & Charles T. Carlstrom, 1992. "The efficiency and welfare effects of tax reform: are fewer tax brackets better than more?," Discussion Paper / Institute for Empirical Macroeconomics 78, Federal Reserve Bank of Minneapolis.
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