IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/24241.html
   My bibliography  Save this paper

Fundamental Tax Reform: The Growth and Utility Effects of a Revenue-Neutral Flat Tax

Author

Listed:
  • Hlavac, Marek

Abstract

We estimate the growth and utility effects of switching from a graduated-rate federal income tax to a flat tax along the lines of Hall-Rabushka (1995). We, furthermore, calculate the post-reform transition dynamics for a number of variables, including the economic growth rate, the representative household’s utility – using consumption equivalents as suggested by Lucas (2003) – , the allocation of time to education and market work, as well as the interest and wage rates. To achieve these goals, we rely on a dynamic equilibrium model proposed by Cassou and Lansing (2003), and calibrated to fit historical data about the U.S. economy and the Internal Revenue Service (IRS) tax return statistics for the 2005 tax year. In the process, we specify a step-by-step calibration procedure for the model – a non-trivial undertaking left largely unexplained in Cassou and Lansing (2003). We find that the flat tax reform increases long-term economic growth, and that the magnitude of this effect depends on the U.S. economy’s intertemporal elasticity of substitution in labor supply (IES). For values of IES that range from 0.25 to 1, the introduction of a Hall-Rabushka flat tax increases the long-term economic growth rate by 0.003 - 0.255 percentage points. Although the flat tax reform has clear benefits in the long run, we find that it decreases economic growth during the first post-reform year, and lowers utility for several years after its implementation. Politicians concerned about their re-election prospects may, as a result, be inclined to carefully consider the political consequences of the flat tax reform in the timing of its adoption.

Suggested Citation

  • Hlavac, Marek, 2008. "Fundamental Tax Reform: The Growth and Utility Effects of a Revenue-Neutral Flat Tax," MPRA Paper 24241, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:24241
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/24241/1/MPRA_paper_24241.pdf
    File Function: original version
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Greenwood, J. & Rogerson, R. & Wright, R., 1993. "Household Production in Real Business Cycle Thoery," RCER Working Papers 347, University of Rochester - Center for Economic Research (RCER).
    2. Conesa, Juan Carlos & Krueger, Dirk, 2006. "On the optimal progressivity of the income tax code," Journal of Monetary Economics, Elsevier, vol. 53(7), pages 1425-1450, October.
    3. Hall, Robert E, 1988. "Intertemporal Substitution in Consumption," Journal of Political Economy, University of Chicago Press, vol. 96(2), pages 339-357, April.
    4. Adi Brender & Allan Drazen, 2005. "How Do Budget Deficits and Economic Growth Affect Reelection Prospects? Evidence from a Large Cross-Section of Countries," NBER Working Papers 11862, National Bureau of Economic Research, Inc.
    5. Paul Gomme & Finn E. Kydland & Peter Rupert, 2001. "Home Production Meets Time to Build," Journal of Political Economy, University of Chicago Press, vol. 109(5), pages 1115-1131, October.
    6. Kevin A. Hassett & Anne Moore, 2005. "How Do Tax Policies Affect Low Income Workers?," AEI Economics Working Papers 49879, American Enterprise Institute.
    7. Butler, Monika, 2000. "The political feasibility of pension reform options: the case of Switzerland," Journal of Public Economics, Elsevier, vol. 75(3), pages 389-416, March.
    8. Eric French, 2004. "The Labor Supply Response to (Mismeasured but) Predictable Wage Changes," The Review of Economics and Statistics, MIT Press, vol. 86(2), pages 602-613, May.
    9. Altonji, Joseph G, 1986. "Intertemporal Substitution in Labor Supply: Evidence from Micro Data," Journal of Political Economy, University of Chicago Press, vol. 94(3), pages 176-215, June.
    10. David Altig, 2001. "Simulating Fundamental Tax Reform in the United States," American Economic Review, American Economic Association, vol. 91(3), pages 574-595, June.
    11. Steven P. Cassou & Kevin J. Lansing, 2004. "Growth Effects of Shifting from a Graduated-rate Tax System to a Flat Tax," Economic Inquiry, Western Economic Association International, vol. 42(2), pages 194-213, April.
    12. repec:bla:econom:v:63:y:1996:i:251:p:495-512 is not listed on IDEAS
    13. The Conference on Research in Income and Wealth, 1960. "Trends in the American Economy in the Nineteenth Century," NBER Books, National Bureau of Economic Research, Inc, number unkn60-1.
    14. Ball, Laurence, 1990. "Intertemporal Substitution and Constraints on Labor Supply: Evidence from Panel Data," Economic Inquiry, Western Economic Association International, vol. 28(4), pages 706-724, October.
    15. Juan C. Conesa & Dirk Krueger, 1999. "Social Security Reform with Heterogeneous Agents," Review of Economic Dynamics, Elsevier for the Society for Economic Dynamics, vol. 2(4), pages 757-795, October.
    16. John C. Ham & Kevin T. Reilly, 2006. "Using Micro Data to Estimate the Intertemporal Substitution Elasticity for Labor Supply in an Implicit Contract Model," IEPR Working Papers 06.54, Institute of Economic Policy Research (IEPR).
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Michal Horvath & Matus Senaj & Zuzana Siebertova & Norbert Svarda, 2015. "The End of the Flat Tax Experiment in Slovakia," Discussion Papers 15/12, Department of Economics, University of York.
    2. Alexander Ludwig & Dirk Krüger & Axel Börsch-Supan, 2009. "Demographic Change, Relative Factor Prices, International Capital Flows, and Their Differential Effects on the Welfare of Generations," NBER Chapters, in: Social Security Policy in a Changing Environment, pages 385-414, National Bureau of Economic Research, Inc.
    3. Dirk Krueger, 2006. "Public Insurance against Idiosyncratic and Aggregate Risk: The Case of Social Security and Progressive Income Taxation," CESifo Economic Studies, CESifo Group, vol. 52(4), pages 587-620, December.
    4. Krueger, Dirk & Ludwig, Alexander, 2007. "On the consequences of demographic change for rates of returns to capital, and the distribution of wealth and welfare," Journal of Monetary Economics, Elsevier, vol. 54(1), pages 49-87, January.
    5. Paul Gomme & Richard Rogerson & Peter Rupert & Randall Wright, 2005. "The Business Cycle and the Life Cycle," NBER Chapters, in: NBER Macroeconomics Annual 2004, Volume 19, pages 415-592, National Bureau of Economic Research, Inc.
    6. Cassou, Steven P. & Gorostiaga, Arantza & Uribe-Zubiaga, Iker, 2013. "Policy effects of the elasticity of substitution across labor types in life cycle models," Economic Modelling, Elsevier, vol. 35(C), pages 59-70.
    7. Christian Jaag, 2005. "The Role of Endogenous Skill Choice in an Aging Economy," Public Economics 0505005, University Library of Munich, Germany.
    8. Daniel Aaronson & Eric French, 2009. "The Effects of Progressive Taxation on Labor Supply when Hours and Wages Are Jointly Determined," Journal of Human Resources, University of Wisconsin Press, vol. 44(2).
    9. Horváth, Michal & Senaj, Matúš & Siebertová, Zuzana & Švarda, Norbert & Valachyová, Jana, 2019. "The end of the flat tax experiment in Slovakia: An evaluation using behavioural microsimulation in a dynamic macroeconomic framework," Economic Modelling, Elsevier, vol. 80(C), pages 171-184.
    10. Sagiri Kitao, 2010. "Labor-dependent Capital Income Taxation That Encourages Work and Saving," 2010 Meeting Papers 271, Society for Economic Dynamics.
    11. Raei, Sepideh, 2020. "Gradual tax reforms: If you like it, you can keep it," Journal of Economic Dynamics and Control, Elsevier, vol. 111(C).
    12. Vipul Bhatt & Masao Ogaki, 2012. "Tough Love And Intergenerational Altruism," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 53(3), pages 791-814, August.
    13. Juan M. Contreras & Sven H. Sinclair, 2008. "The Labor Supply Response in Macroeconomic Models: Working Paper 2008-07," Working Papers 20141, Congressional Budget Office.
    14. Panousi, Vasia, 2009. "Capital Taxation with Entrepreneurial Risk," MPRA Paper 24237, University Library of Munich, Germany.
    15. Mankiw, N Gregory, 1989. "Real Business Cycles: A New Keynesian Perspective," Journal of Economic Perspectives, American Economic Association, vol. 3(3), pages 79-90, Summer.
    16. Kris Jacobs, 2001. "Estimating Nonseparable Preference Specifications for Asset Market Participants," CIRANO Working Papers 2001s-12, CIRANO.
    17. Marta González-Torrabadella & Josep Pijoan-Mas, 2006. "Flat tax reforms: a general equilibrium evaluation for Spain," Investigaciones Economicas, Fundación SEPI, vol. 30(2), pages 317-351, May.
    18. Berger, Johannes & Strohner, Ludwig, 2020. "Documentation of the PUblic Policy Model for Austria and other European countries (PUMA)," Research Papers 11, EcoAustria – Institute for Economic Research.
    19. Constantine Angyridis & Brennan Scott Thompson, 2016. "Negative income taxes, inequality and poverty," Canadian Journal of Economics, Canadian Economics Association, vol. 49(3), pages 1016-1034, August.
    20. Juan Carlos Conesa & Sagiri Kitao & Dirk Krueger, 2009. "Taxing Capital? Not a Bad Idea after All!," American Economic Review, American Economic Association, vol. 99(1), pages 25-48, March.

    More about this item

    Keywords

    tax; flat tax; public finance; economic growth; tax reform;
    All these keywords.

    JEL classification:

    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy; Modern Monetary Theory
    • H20 - Public Economics - - Taxation, Subsidies, and Revenue - - - General
    • O40 - Economic Development, Innovation, Technological Change, and Growth - - Economic Growth and Aggregate Productivity - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:24241. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Joachim Winter (email available below). General contact details of provider: https://edirc.repec.org/data/vfmunde.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.