DP5280 Consumption Taxes and Redistribution

Author(s): Isabel Correia
Publication Date: October 2005
Keyword(s): consumption taxes, equity, fundamental tax reform, heterogeneous agents
JEL(s): D63, E62, H20
Programme Areas: International Macroeconomics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=5280

It is relatively well known that the introduction of consumption taxation as an alternative in the tax code, and as the main source of government revenues, leads to a more efficient tax system. However the conventional wisdom is that the change from the actual tax code, based on taxation of capital and labour income to this consumption-based system, has undesirable distributional consequences. In this work a very simple method is developed to argue that the converse is the most reasonable outcome from that fundamental tax reform. The main difference in relation to the literature comes from the assumed source of household heterogeneity. Additionally it is shown that the inclusion of a tax on consumption allows for redistributive policies with no costs in terms of efficiency.