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The Welfare Cost of Uncertain Tax Policy

  • Jonathan S. Skinner

Frequent shifts in tax policy can increase uncertainty about future net-of-tax wages and interest income. This paper measures the impact of uncertain tax policy on savings, labor supply, and welfare in the United States. A vector autoregression model with six variables was estimated which found the standard error of the one-year-ahead forecast for the wage tax to be 1.8 percentage points, and for the interest income tax 3.3 percentage points. Furthermore, the negative correlation between unanticipated shifts in the real interest rate and changes in the interest income tax amplifies the variability in the real after-tax return. A two-period model of consumption and labor supply is developed that measures the effect of uncertain taxes on savings, work hours, and taxpayer welfare. Using plausible empirical parameters, it is shown that removing all uncertainty about future tax policy can lead to a welfare gain of 0.4 percent of national income, or about 12 billion dollars in 1985.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 1947.

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Date of creation: Jun 1986
Date of revision:
Publication status: published as Journal of Public Economics, November 1988, vol. 37, pp. 129-145.
Handle: RePEc:nbr:nberwo:1947
Note: PE
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  1. Don Fullerton & Marios Karayannis, 1987. "The Taxation of Income from Capital in the United States, 1980-86," NBER Working Papers 2478, National Bureau of Economic Research, Inc.
  2. Alan J. Auerbach & Laurence J. Kotlikoff & Jonathan Skinner, 1981. "The Efficiency Gains from Dynamic Tax Reform," NBER Working Papers 0819, National Bureau of Economic Research, Inc.
  3. Hansen, Lars Peter & Singleton, Kenneth J, 1983. "Stochastic Consumption, Risk Aversion, and the Temporal Behavior of Asset Returns," Journal of Political Economy, University of Chicago Press, vol. 91(2), pages 249-65, April.
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  8. Weber, Warren E, 1975. "Interest Rates, Inflation, and Consumer Expenditures," American Economic Review, American Economic Association, vol. 65(5), pages 843-58, December.
  9. Robert E. Hall, 1985. "Real Interest and Consumption," NBER Working Papers 1694, National Bureau of Economic Research, Inc.
  10. Robert J. Barro, 1984. "The Behavior of U.S. Deficits," NBER Working Papers 1309, National Bureau of Economic Research, Inc.
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  12. Gilbert Ghez & Gary S. Becker, 1975. "The Allocation of Time and Goods over the Life Cycle," NBER Books, National Bureau of Economic Research, Inc, number ghez75-1, July.
  13. Kanbur, S M Ravi, 1983. "Labour Supply under Uncertainty with Piecewise Linear Tax Regimes," Economica, London School of Economics and Political Science, vol. 50(200), pages 379-94, November.
  14. Stiglitz, Joseph E, 1969. "The Effects of Income, Wealth, and Capital Gains Taxation on Risk-Taking," The Quarterly Journal of Economics, MIT Press, vol. 83(2), pages 263-83, May.
  15. Eaton, Jonathan & Rosen, Harvey S., 1980. "Labor supply, uncertainty, and efficient taxation," Journal of Public Economics, Elsevier, vol. 14(3), pages 365-374, December.
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