Consumption taxes and economic efficiency with idiosyncratic wage shocks

Nishiyama, Shinichi and Smetters, Kent (2005) Consumption taxes and economic efficiency with idiosyncratic wage shocks. Journal of Political Economy, 113 (5). pp. 1088-1115. ISSN 0022-3808

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Fundamental tax reform is examined in an overlapping-generations model in which heterogeneous agents face idiosyncratic wage shocks and longevity uncertainty. A progressive income tax is replaced with a flat consumption tax. If idiosyncratic wage shocks are insurable (i.e., no risk), this reform improves (interim) efficiency, a result consistent with the previous literature. But if, more realistically, wage shocks are uninsurable, this reform reduces efficiency, even though national wealth and output increase over the entire transition path. This efficiency loss, in large part, stems from reduced intragenerational risk sharing that was previously provided by the progressive tax system.

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Journal Article
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Journal of Political Economy
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12 Aug 2015 08:34
Last Modified:
22 Nov 2022 02:07