The Effect of Tax Reform in a Dynamic General Equilibrium Framework - Ramsey vs. Overlapping Generation Model

Abstract

Based on a thorough comparison of the basic assumptions and economic underpinning of the Ramsey and over lapping generation (OLG) model, this study builds both static and dynamic computable general equilibrium tax policy models to analyze the effect of tax reform on Taiwan’s economy. The new tax structure considers mainly a replacement of some parts of labor and capital income taxes by consumption tax. The benchmark year of the model is 2001, and the economy is divided into four sectors. The modeling framework is implemented on top of MPSGE, which is a special module within the General Algebraic Modeling System (GAMS). Our simulation results show differential outcomes for static and dynamic models. The slower speed of transition inherent in OLG model has caused variables such as welfare, capital stock, and replacement consumption tax rate change less than that in the Ramsey model when the tax reform policy is imposed. And the intergeneration effects of different tax burden between young and old generations can be found in the OLG model but not in the Ramsey model.