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The effects of the consumption tax proposals on GDP are generally positive over the medium and long terms, although the magnitude of these effects varies widely. For example, the Jorgenson-Wilcoxen model predicts that under a consumption tax, real GDP would be 3. The Auerbach, Kotlikoff, Smetters, and Walliser model predicts even greater gains in the long run 7. Similarly, the Engen-Gale analysis shows that the capital stock would be 9. It would increase the capital stock and raise the level of national output by between 1 percent and 10 percent, although CBO concludes that increases at the upper end of the range are unlikely.

The reform might be expected to increase economic efficiency as well as output for a number of reasons, according to the CBO study. First, the switch to a consumption base would eliminate the influence of taxes on the timing of consumption. Second, the new system might treat different sources of income more uniformly by including more of them in the tax base and subjecting all of them to similar tax rates.

Third, a broader base would allow lower overall marginal tax rates, reducing the amount by which taxes affect relative prices and hence all kinds of economic decisions.

Fundamental Issues in Consumption Taxation AEI Studies on Tax Reform

CBO notes, however, that efficiency is not the only criterion to use in judging the desirability of tax reform. Administrative and compliance costs are other important factors.

If a consumption tax offered substantial gains from reduced complexity, then even a minimal gain in economic efficiency would be an added bonus. Table Engen of the Federal Reserve Board of Governors and Professor Jonathan Skinner of Dartmouth College, examines evidence on taxation and growth for a large sample of countries.

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ISBN 13: 9780844770697

Figures 7 and 8 show the correlation between income taxes and economic growth and between consumption taxes and economic growth over the period — in countries of the Organization for Economic Cooperation and Development OECD. The authors note that these scatter plots, largely confirmed in regression analysis, suggest that income taxation is more harmful to growth than broad-based consumption taxes. For example, a major tax reform plan which reduces marginal tax rates by 5 percentage points will increase growth by 0. Even modest growth effects can have an important long-term impact on living standards, Engen and Skinner note.

For example, suppose that inefficiency in the structure of taxation has, since , retarded growth by 0. Accumulated over the past 36 years, the lower growth rate translates to a 7. Thus, the potential effects of tax policy, although difficult to detect in the time-series data, can have very large effects over the long term. A recent survey by Dr. Kevin Hassett of the American Enterprise Institute, Tax Policy and Investment, 13 notes that elasticity of investment with respect to the user cost of capital is between If the United States adopted a consumption tax, Hassett concludes, the user cost of capital would fall to 0.

Tax Reform and Economic Growth , 14 show that switching from the income tax to a consumption tax produces a welfare gain for the United States of several trillion dollars. Finally, a recent unpublished study by Dr.


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Allen Sinai of Primark Decision Economics shows that if the United States had switched in to a consumption tax system, in which all investment was expensed, all saving was deductible, and interest expense was not deductible, U. Fundamental reform of the U. In addition to political factors such as voter discontent with the income tax, several factors contribute to the current interest in tax reform.

Taxing Wealth and Capital Income | Cato Institute

A substantial body of research suggests that fundamental tax reform and more reliance on consumption taxes could have a profound, positive effect on long-term economic growth. Even small changes in economic growth rates can make a big difference in living standards. Kevin A. Dale W. Economic Growth Cambridge, Mass. Alan J. Auerbach, David Altig, Laurence J. Kotlikoff, Kent A. Eric M. Table A. About the Author. Thorning is an internationally recognized expert on tax, environmental, and competitiveness issues.

She writes and lectures on tax and economic policy, is frequently quoted in the national and local press including the Wall Street Journal, Fortune , and the Washington Post , and has appeared on national public affairs news programs. Thorning has testified as an expert witness on capital formation and environmental issues before various U.


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Previously , Dr. Thorning served at the U. Department of Energy, the U. Department of Commerce, and the Federal Trade Commission. Thorning received a B. February 1, U. Capital Formation: How the U. Introduction: The Link Between Saving and Investment Saving matters primarily because the investment it finances determines the growth of income and living standards in a country. Table 2 Capital Intensity of U. Computer Chips. Telephone Switching Equipment. Factory Robots. Continuous Casting for Steel Production.

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Engine Blocks. Wastewater Treatment for Chemical Production. Wastewater Treatment for Pulp and Paper Equipment. Scrubbers Used in Electricity Plants. As a percent of cost. Nonresidential Structures. Residential Structures. Inventories and Land. Tax Rate.

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Individual Holding Period. Corporate Holding Period. Total — FY — Changes from baseline, cumulative except as otherwise noted. Consumption Tax. Unified Income Tax. Average Billions of dollars. Cumulative — Retail Sales Tax. Gephardt 10 Percent Tax. Agriculture, forestry, fishing. Transportation and public utilities. Wholesale and retail trade. Finance, insurance, and real estate. Department of Commerce. Sources: U. Government Printing Office. MACRS 1.


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