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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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  • Charles L. Ballard & John B. Shoven & John Whalley, 1982. "The Welfare Cost of Distortions in the United States Tax System: A General Equilibrium Approach," NBER Working Papers 1043, National Bureau of Economic Research, Inc.
    • Handle: RePEc:nbr:nberwo:1043
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    1. C E McLure Jr, 1984. "The Evolution of Tax Advice and the Taxation of Capital Income in the USA," Environment and Planning C, , vol. 2(3), pages 251-269, September.
    2. Becker, Gary S & Mulligan, Casey B, 2003. "Deadweight Costs and the Size of Government," Journal of Law and Economics, University of Chicago Press, vol. 46(2), pages 293-340, October.
    3. Sh. Enkhbayar, 2015. "The Marginal Welfare Burden of Mongolia's Tax System," The Northeast Asian Economic Review, ERINA - Economic Research Institute for Northeast Asia, vol. 3(2), pages 55-68, October.
    4. Blank, Rebecca M., 2002. "Can equity and efficiency complement each other?," Labour Economics, Elsevier, vol. 9(4), pages 451-468, September.
    5. 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).
    6. Joel Slemrod, 1985. "The Impact of Tax Reform on Households," NBER Working Papers 1765, National Bureau of Economic Research, Inc.
    7. Mr. David Coady & Ian W.H. Parry & Louis Sears & Baoping Shang, 2015. "How Large Are Global Energy Subsidies?," IMF Working Papers 2015/105, International Monetary Fund.
    8. Cole, Rebel, 2011. "How do firms choose legal form of organization?," MPRA Paper 32591, University Library of Munich, Germany.
    9. James R. Hines, 1999. "Three Sides of Harberger Triangles," Journal of Economic Perspectives, American Economic Association, vol. 13(2), pages 167-188, Spring.
    10. Cedric Sandford, 1992. "Worldwide Tax Reform ‘How Does Australia Compare?’," Australian Economic Review, The University of Melbourne, Melbourne Institute of Applied Economic and Social Research, vol. 25(1), pages 22-32, January.
    11. 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.
    12. Enkhbayar Shagdar & Otgonsaikhan Nyamdaa, 2017. "Impacts of Import Tariff Reforms on Mongolia's Economy: CGE Analysis with the GTAP 8.1 Data Base," The Northeast Asian Economic Review, ERINA - Economic Research Institute for Northeast Asia, vol. 5(1), pages 1-25, March.
    13. B.P.J. Van Rensburg, 1990. "Tax Reform Issues in South Africa in the 1990s," South African Journal of Economics, Economic Society of South Africa, vol. 58(1), pages 1-11, March.
    14. Blinder, Alan S & Rosen, Harvey S, 1985. "Notches," American Economic Review, American Economic Association, vol. 75(4), pages 736-747, September.
    15. 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.
    16. John Ataguba, 2012. "Alcohol policy and taxation in South Africa," Applied Health Economics and Health Policy, Springer, vol. 10(1), pages 65-76, January.
    17. Peichl, Andreas & Bergs, Christian, 2006. "Numerische Gleichgewichtsmodelle - Grundlagen und Anwendungsgebiete," FiFo Discussion Papers - Finanzwissenschaftliche Diskussionsbeiträge 06-2, University of Cologne, FiFo Institute for Public Economics.
    18. Aradhyula, Satheesh Venkata, 1989. "Policy structure, output supply and input demand for US crops," ISU General Staff Papers 198901010800009909, Iowa State University, Department of Economics.
    19. Boris I. Alekhin, 2020. "Tax Smoothing in Russia," Finansovyj žhurnal — Financial Journal, Financial Research Institute, Moscow 125375, Russia, issue 2, pages 9-24, April.

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