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The Design of a Consumption Tax under Capital Risk

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  • Syed M. Ahsan
  • Peter Tsigaris

Abstract

This paper focuses on the design of a consumption tax in a world of capital risk. The certainty literature discusses two standard options, namely the cash flow method and the pre-payment method (ie, the wage tax), and finds the two approaches to be equivalent. Models that consider capital risk (via asset choice) reach different conclusions. This discrepancy arises out of different choice of the social discount rate. In light of the failure of the discount rate argument to resolve the issue at hand, we explore the market certainty equivalence of risky government revenue. We let revenue risks stay in the private sector, and examine the market value of the size of the feasible transfer (eg, in the form of a public good) back to households. We reach three broad conclusions. First, we find that in two important settings, namely where households do not diversify fully, and where there is some intergenerational risk sharing (eg, through public debt management), the wage tax cannot be construed to be a valid pre-payment alternative to the cash flow tax. Efficient risk allocation would call for a cash-flow tax, or one that includes future capital gains as well as wages in the tax base. Secondly, it is seen that in each of these scenarios, there is room for welfare gain in the case of a consumption tax instead of the conventionally "equivalent" wage tax. Finally, a major policy implication is that, in order to be practicable, a consumption tax would have to be implemented via registered savings accounts much in the fashion of the Canadian RRSP program rather than through the pre-payment route.

Suggested Citation

  • Syed M. Ahsan & Peter Tsigaris, "undated". "The Design of a Consumption Tax under Capital Risk," EPRU Working Paper Series 97-11, Economic Policy Research Unit (EPRU), University of Copenhagen. Department of Economics.
  • Handle: RePEc:kud:epruwp:97-11
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    References listed on IDEAS

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    1. Auerbach, Alan J, 1991. "Retrospective Capital Gains Taxation," American Economic Review, American Economic Association, vol. 81(1), pages 167-178, March.
    2. Ahsan, Syed M., 1989. "Choice of tax base under uncertainty : Consumption or income?," Journal of Public Economics, Elsevier, vol. 40(1), pages 99-134, October.
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    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 533-544, September.
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    12. Robert C. Merton, 1983. "On the Role of Social Security as a Means for Efficient Risk Sharing in an Economy Where Human Capital Is Not Tradable," NBER Chapters,in: Financial Aspects of the United States Pension System, pages 325-358 National Bureau of Economic Research, Inc.
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    15. Arrow, Kenneth J & Lind, Robert C, 1970. "Uncertainty and the Evaluation of Public Investment Decisions," American Economic Review, American Economic Association, vol. 60(3), pages 364-378, June.
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    17. Sandmo, Agnar, 1972. "Discount Rates for Public Investment under Uncertainty," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 13(2), pages 287-302, June.
    18. Wolfram F. RICHTER & Wolfgang WIEGARD, 1991. "On the Diferrence between Income and Consumption Taxes when the Return to Savings is uncertain," Discussion Papers (REL - Recherches Economiques de Louvain) 1991044, Université catholique de Louvain, Institut de Recherches Economiques et Sociales (IRES).
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    Cited by:

    1. Paolo M. Panteghini, 2009. "On the equivalence between labor and consumption taxation," Economics Bulletin, AccessEcon, vol. 29(2), pages 622-629.
    2. Dirk Schindler, 2008. "Taxing Risky Capital Income - A Commodity Taxation Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(3), pages 311-333, September.
    3. Syed M. Ahsan & Panagiotis Tsigaris, 2009. "The Efficiency Loss of Capital Income Taxation under Imperfect Loss Offset Provisions," Public Finance Review, , vol. 37(6), pages 710-731, November.
    4. Hans-Werner Sinn, 1999. "Inflation and Welfare: Comment on Robert Lucas," NBER Working Papers 6979, National Bureau of Economic Research, Inc.
    5. Syed M. Ahsan & Panagiotis Tsigaris, 2003. "Choice of Tax Base Revisited: Cash Flow vs. Prepayment Approaches to Consumption Taxation," CESifo Working Paper Series 983, CESifo Group Munich.
    6. Syed Ahsan & Panagiotis Tsigaris, 2002. "Measuring the Social Discount Rate under Uncertainty: A Methodology and Application," CESifo Working Paper Series 824, CESifo Group Munich.

    More about this item

    JEL classification:

    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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