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The Welfare Cost of Distortions in the United States Tax System: A General Equilibrium Approach

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  • Charles L. Ballard
  • John B. Shoven
  • John Whalley

Abstract

Using a general equilibrium model of the United States economy,we examine the combined welfare cost of all taxes in the U.S. revenue system.We find that the welfare losses caused by distortionary taxation can be very large, both on average and at the margin.The marginal welfare loss to consumers from raising an additional dollar of revenue is in the range of 34 cents to 48 cents, depending on certain elasticities. This has very important implications for cost-benefit analysis.If a public project must be financed by distortionary taxes which cause dead-weight loss, this excess burden must be taken into account when we decide whether to undertake the project. Our calculations indicate that the marginal deadweight loss is between one-third and one-half of marginal revenues. This large wedge could cause us to approve many fewer projects than we would approve if we were to use the simple condition that the sum of the marginal rates of substitution should equal the marginal rate of transformation.The average deadweight loss per dollar of revenue is smaller than the marginal deadweight loss, but it is still substantial. We estimate that the present value of the gain from replacing the distortionary tax system with certain lump sum taxes would be in the range of $1.8 trillion to $3.1 trillion,or 13 cents to 22 cents per dollar of revenue. The gains would be about 60 percent as great if the existing system were replaced with a proportional income tax. Replacing the existing system with a consumption-type value-added tax would give even greater gains than those from switching to a proportional income tax.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1043.

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Date of creation: Dec 1982
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Publication status: published as Ballard, Charles L., John B. Shoven and John Whalley. "General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States." American Economic Review, Vol. 75, No. 1, (March1985), pp. 128-138.
Handle: RePEc:nbr:nberwo:1043

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  1. Arnold C. Harberger, 1962. "The Incidence of the Corporation Income Tax," Journal of Political Economy, University of Chicago Press, vol. 70, pages 215.
  2. Fullerton, Don, et al, 1981. "Corporate Tax Integration in the United States: A General Equilibrium Approach," American Economic Review, American Economic Association, vol. 71(4), pages 677-91, September.
  3. Alan J. Auerbach & Laurence J. Kotlikoff & Jonathan Skinner, 1981. "The Efficiency Gains from Dynamic Tax Reform," NBER Working Papers 0819, National Bureau of Economic Research, Inc.
  4. Atkinson, Anthony B & Stern, N H, 1974. "Pigou, Taxation and Public Goods," Review of Economic Studies, Wiley Blackwell, vol. 41(1), pages 119-28, January.
  5. Lawrence H. Goulder & John B. Shoven & John Whalley, 1982. "Domestic Tax Policy and the Foreign Sector: The Importance of Alternative Foreign Sector Formulations to Results from a General Equilibrium," NBER Working Papers 0919, National Bureau of Economic Research, Inc.
  6. Browning, Edgar K, 1976. "The Marginal Cost of Public Funds," Journal of Political Economy, University of Chicago Press, vol. 84(2), pages 283-98, April.
  7. George J. Borjas & James J. Heckman, 1978. "Labor Supply Estimates For Public Policy Evaluation," NBER Working Papers 0299, National Bureau of Economic Research, Inc.
  8. Summers, Lawrence H, 1981. "Capital Taxation and Accumulation in a Life Cycle Growth Model," American Economic Review, American Economic Association, vol. 71(4), pages 533-44, September.
  9. Charles L. Ballard & Don Fullerton & John B. Shoven & John Whalley, 1985. "General Equilibrium Analysis of Tax Policies," NBER Chapters, in: A General Equilibrium Model for Tax Policy Evaluation, pages 6-24 National Bureau of Economic Research, Inc.
  10. Shoven, John B & Whalley, John, 1973. "General Equilibrium with Taxes: A Computational Procedure and an Existence Proof," Review of Economic Studies, Wiley Blackwell, vol. 40(4), pages 475-89, October.
  11. Stiglitz, Joseph E., 1973. "Taxation, corporate financial policy, and the cost of capital," Journal of Public Economics, Elsevier, vol. 2(1), pages 1-34, February.
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Cited by:
  1. Schimmelpfennig, David E. & Norton, George W., 2000. "What Value Is Agricultural Economics Research?," 2000 Annual meeting, July 30-August 2, Tampa, FL 21773, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
  2. Joel Slemrod, 1985. "The Impact of Tax Reform on Households," NBER Working Papers 1765, National Bureau of Economic Research, Inc.
  3. James R. Hines, Jr., 1998. "Three Sides of Harberger Triangles," NBER Working Papers 6852, National Bureau of Economic Research, Inc.
  4. Austan Goolsbee, 2002. "The Impact and Inefficiency of the Corporate Income Tax: Evidence from State Organizational Form Data," NBER Working Papers 9141, National Bureau of Economic Research, Inc.
  5. John Ataguba, 2012. "Alcohol policy and taxation in South Africa," Applied Health Economics and Health Policy, Springer, vol. 10(1), pages 65-76, January.
  6. Alan S. Blinder & Harvey S. Rosen, 1984. "Notches," NBER Working Papers 1416, National Bureau of Economic Research, Inc.
  7. Rebecca M. Blank, 2002. "Can Equity and Efficiency Complement Each Other?," NBER Working Papers 8820, National Bureau of Economic Research, Inc.
  8. Gary S. Becker & Casey B. Mulligan, 1998. "Deadweight Costs and the Size of Government," University of Chicago - George G. Stigler Center for Study of Economy and State 144, Chicago - Center for Study of Economy and State.
  9. Cole, Rebel, 2011. "How do firms choose legal form of organization?," MPRA Paper 32591, University Library of Munich, Germany.
  10. Athiphat Muthitacharoen & George R. Zodrow, 2008. "The Efficiency Costs of Local Property Tax," International Center for Public Policy Working Paper Series, at AYSPS, GSU paper0815, International Center for Public Policy, Andrew Young School of Policy Studies, Georgia State University.

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