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Gradual tax reforms: If you like it, you can keep it

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  • Raei, Sepideh

Abstract

One of the key practical challenges facing by tax reforms are their short-run welfare consequences. In this paper I focus on a consumption-based tax reform for which, despite long-run welfare gains it generates, welfare for some groups such as retirees, or the working poor, falls during transition between steady states. Using a life-cycle model with heterogeneous households, I show how to devise a transition path from the current U.S. Federal tax system to a consumption-based tax system that improves the welfare of current as well as future generations. In a nutshell, all households alive at the time of the policy change can choose when they want to switch to the new tax system, or whether they want to switch at all. I find that implementing a tax reform with this feature improves the welfare of 95% of population in the short-run, compared to less than a quarter of population in the conventional case with no choice. It takes about twenty years for half of the population to pay their taxes under the new tax code.

Suggested Citation

  • Raei, Sepideh, 2020. "Gradual tax reforms: If you like it, you can keep it," Journal of Economic Dynamics and Control, Elsevier, vol. 111(C).
  • Handle: RePEc:eee:dyncon:v:111:y:2020:i:c:s0165188919301903
    DOI: 10.1016/j.jedc.2019.103793
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