Journal Article

Consumption taxes : macroeconomic effects and policy issues

Abstract: Proposals for fundamental reform of the federal tax code are receiving increased attention in the business press and among economic analysts and policymakers. President Bush has identified tax reform as a top priority, calling for a tax system that is ?pro-growth, easy to understand, and fair to all.? Moreover, the President has appointed a commission to consider different approaches to tax reform. One approach might be to improve the current income-based federal tax code, perhaps by broadening the tax base and lowering income-tax rates. However, another approach might be to replace current income taxes altogether with a consumption tax. Switching the federal tax system from an income tax to a consumption tax could have important macroeconomic effects. Most economists believe that switching to a consumption tax could increase saving and real output per person over the long run, although studies differ on the size of these effects. However, switching to a consumption tax might also require sizable short-run economic adjustments and create challenges for monetary policymakers. Garner analyzes the macroeconomic effects of replacing the current federal tax system with a consumption tax. First, he provides some background on the goals of tax reform and the basic difference between an income tax and a consumption tax. Next, he describes three widely discussed versions of a consumption tax: a national retail sales tax, a value-added tax, and a consumption-type flat tax. Finally, he examines the macroeconomic effects of adopting a consumption tax. All three proposals could raise U.S. output over the long run, but adopting a consumption tax could have sizable transition effects as well. These transition effects could vary depending on which consumption tax was adopted and how monetary policy responded to the reforms.

Keywords: Taxation; Consumption (Economics); Tax reform;

Bibliographic Information

Provider: Federal Reserve Bank of Kansas City

Part of Series: Economic Review

Publication Date: 2005

Volume: 90

Issue: Q II

Pages: 5-29