Macroeconomic Impacts of Consumption and Income Taxes

Abstract

Macroeconomic impacts of consumption and income taxes are higher when both of them rather than only one of them are employed to raise a fixed amount of revenue that is given back to households as transfers. We apply a general equilibrium model to assess no tax, only consumption tax or only labour income tax policy alternatives in comparison to a benchmark economy in which both taxes apply to the consumption and labour income of a representative household in an economy. We find that switching to only consumption tax would improve efficiency while raising the target level revenue than in the mix of two tax case. These gains are about 80 percent of the no tax scenario. Taxing only on consumption to raise a given amount of revenue is better in terms of labour supply, lower optimal tax rates and level of utility of the household from consumption and leisure. Model applied to the UK also confirms that the consumption taxes have significantly lower burden than the labour income tax or of the combination of both consumption and labour income taxes.