Evaluation of a consumption tax reform in a dynamic simulation model
Johnson, Craig E.
Zodrow, George R.
Doctor of Philosophy
In this dissertation, I develop a dynamic general equilibrium simulation model with overlapping generations divided into 12 lifetime income groups to examine the economic effects of replacing the current U.S. federal personal and corporate income tax system with a broad-based consumption tax. This model extends previous research in a number of directions; in particular, it models tax-deferred assets explicitly and allows for progressive capital income tax rates. The results indicate that the inclusion of tax-deferred assets favorably affects the welfare of the oldest generations at the time of reform in middle and upper income groups. In addition, the consumption tax reform is more regressive in the transition and steady-state with the explicit inclusion of tax-deferred assets when compared to a base case where the taxation of pensions is modeled as a flat rate consumption tax. Allowing capital tax rates to vary progressively across the 12 income groups has the expected effect of increasing welfare gains to upper income groups during the transition and steady-state, while reducing the welfare of lower income groups. This dissertation also examines the importance of wage profiles and bequests on consumption tax reform-induced welfare changes. Age-wage profiles estimated from the Panel Study of Income Dynamics greatly improve previous estimates. Wage profiles from a sample consisting only of heads of households leads to a wider distribution in income earned across the lifetime income groups compared to a sample that includes wives, and thus a larger variance in the distribution of welfare changes induced by a consumption tax reform. Bequests are a significant determinant of welfare changes only for elderly households alive at the time of reform.