DP8238 Flat Tax Reforms: Investment Expensing and Progressivity

Author(s): Javier Díaz-Giménez, Josep Pijoan-Mas
Publication Date: February 2011
Keyword(s): Efficiency, Flat-tax reforms, Inequality, Progressivity
JEL(s): D31, E62, H23
Programme Areas: International Macroeconomics, Public Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8238

In this article we quantify the aggregate, distributional and welfare consequences of investment expensing and progressivity in flat-tax reforms of the United States economy. We find that investment expensing as in the Hall and Rabushka type of reform brings about sizable output gains and a non-trivial increase in after-tax income inequality. But we also find that it results in large aggregate welfare gains in steady-state. Two additional flat-tax reforms with full investment expensing and varying degrees of progressivity reveal that the distributional role of the tax-exemption in the labor income tax is limited. But we also find that the progressivity of the reforms matters for welfare: economies with more progressive consumption-based flat-taxes are good for the very poor and are ultimately preferred by a Benthamite social planner because they allow households to do more consumption and leisure smoothing. Our findings suggest that moving towards a progressive consumption-based flat tax scheme could achieve the goals of raising government income, stimulating the economy and providing a safety net for the households that have been hit the hardest by the recession