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Distributional Implications of Introducing a Broad-Based Consumption Tax

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  • William M. Gentry
  • R. Glenn Hubbard

Abstract

As a tax base, 'consumption' is sometimes argued to be less fair than 'income' because the benefits of not taxing capital income accrue to high-income households. We argue that, despite the common perception that consumption taxation eliminates all taxes on capital income, consumption and income taxes actually treat similarly much of what is commonly called capital income. Indeed, relative to an income tax, a consumption tax exempts only the tax on the opportunity cost of capital. In contrast to a pure income tax, a consumption tax replaces capital depreciation with capital expensing. This change eliminates the tax on the opportunity cost of capital, but does not change, relative to the income tax, the tax treatment of capital income arising from a risk premium, inframarginal profit, or luck. Because these components of capital income are more heavily skewed toward the top of the distribution of economic well-being, a consumption tax is more progressive than would be estimated under conventional distributional assumptions. We prepare distribution tables and demonstrate that this modification is quantitatively important.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 5832.

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Date of creation: Nov 1996
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Publication status: published as Distributional Implications of Introducing a Broad-Based Consumption Tax , William M. Gentry, R. Glenn Hubbard. in Tax Policy and the Economy, Volume 11 , Poterba. 1997
Handle: RePEc:nbr:nberwo:5832

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  1. David Bradford, . "Consumption Taxes: Some Fundamental Transition Issues," EPRU Working Paper Series 95-15, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  2. Robert E. Hall, 1996. "The Effects of Tax Reform on Prices and Asset Values," NBER Chapters, in: Tax Policy and the Economy, Volume 10, pages 71-88 National Bureau of Economic Research, Inc.
  3. Martin Feldstein, 1995. "The Effect of a Consumption Tax on the Rate of Interest," NBER Working Papers 5397, National Bureau of Economic Research, Inc.
  4. Scholz, J.K., 1993. "Tax Progressivity and Household Portfolio: Descriptive Evidence from the Surveys of Consumer Finances," Working papers 9304, Wisconsin Madison - Social Systems.
  5. Daniel R. Feenberg & Andrew W. Mitrusi & James M. Poterba, 1997. "Distributional Effects of Adopting a National Retail Sales Tax," NBER Chapters, in: Tax Policy and the Economy, Volume 11, pages 49-90 National Bureau of Economic Research, Inc.
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