Consumption Taxation and Tax Prepayment Approach in Dynamic General Equilibrium Models with Consumer Durables

This paper reexamines the dynamic impacts of the proportional consumption tax in a perfect foresight model of general equilibrium with nondurable and durable consumption goods as well as productive capital. In contrast to the previous literature, it is shown that the consumption tax is not neutral with respect to the consumption/savings decisions, even if labor supply is fixed and if the tax revenues are fully returned to consumers in a lump-sum way. Moreover its increase reduces the overall welfare defined along the transitional path as well as in the ultimate steady state equilibrium. Although how the consumption tax affects the speed of capital accumulation along the transitional path depends on the form of utility functions, in a model with plausible preferences and reasonable parameter values, an increase in the consumption tax adversely affects that speed, i.e., savings.