Labour or consumption taxes? An application with a dynamic general equilibrium model with heterogeneous agents

Working Papers 264 Markku Lehmus

This study analyzes the effects of tax reform that shifts tax burden from labour to consumption. In this context, I also deal with the issue of progressivity. Even though this kind of tax policy change has recently gained popularity, its positive effects are debatable while the offsetting effect of a consumption tax on labour supply makes the net welfare change rather ambiguous. I examine these effects using a dynamic general equilibrium model with heterogeneous agents. The model is calibrated to fit certain characteristics of the Finnish economy. In addition to efficiency effects, I study the tax reform’s effect on income and wealth distribution. First, I find that eliminating progressivity in labour taxation increases efficiency via increase in capital accumulation that comes, however, in expense of slightly more inequality. Then, tax reform that replaces progressive labour taxes with a flat-rate consumption tax leads to a significant rise in capital accumulation, a negligible change in labour supply and gross labour income distribution, but a relatively considerable increase in wealth concentration.

Published: 1.10.2010
ISBN: 978-952-209-086-7
ISSN: 1795-1801
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