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Consumption taxes : macroeconomic effects and policy issues

Listed author(s):
  • C. Alan Garner
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    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.

    Volume (Year): (2005)
    Issue (Month): Q II ()
    Pages: 5-29

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    Handle: RePEc:fip:fedker:y:2005:i:qii:p:5-29:n:v.90no.2
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    1. John E. Golob, 1995. "How would tax reform affect financial markets?," Economic Review, Federal Reserve Bank of Kansas City, issue Q IV, pages 19-39.
    2. David Altig, 2001. "Simulating Fundamental Tax Reform in the United States," American Economic Review, American Economic Association, vol. 91(3), pages 574-595, June.
    3. Lucas, Robert Jr, 1976. "Econometric policy evaluation: A critique," Carnegie-Rochester Conference Series on Public Policy, Elsevier, vol. 1(1), pages 19-46, January.
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