We evaluate the growth and welfare effects of budget-neutral reforms in the US tax system. Large gains in welfare and growth could result from adopting a consumption-based tax system. In contrast, significant welfare and growth losses would follow after implementing an income tax-based reform. Eliminating double taxation of firms' profits would yield non-negligible welfare and growth gains.
Tax systems are complex and include different rates for different taxes as well as double taxation on capital gains. The discussion on the issue of taxation on factor income is determined by normative views of society and in the USA it is also at the center of the policy debate between republicans and democrats. While republicans argue that capital is double taxed and ask for a null taxation of capital, democrats argue that capital should be more heavily taxed to decrease inequality (see, e.g., Berlau and Kovacs, 2012). The Economist, on the February 2012 edition,2 has asked well-reputed economists “How should governments tax capital?” Scott Summer, Hall Varian, Brad deLong, Tom Gallagher, David Li and Gilles Saint-Paul wrote about capital taxation and taxation reforms. All those economists seem to agree that increasing taxes or double tax capital income may deter growth and welfare. Some, as Varian and Gallager clearly advocate a consumption-based tax reform while Summer assumes that capital taxation is inefficient and that it represents a sort of ‘double taxation’ of labor income. There are also completely opposite opinions that argue that investment income is simply not earned so it should be taxed.3 A discussion about streamlining the US fiscal system, by adopting a consumption-based tax or alleviating double taxation of capital gains, including potential effects on growth, can also be found in Lowrey and Kocieniewski (2012).4 In fact, in 2003, G. W. Bush already purposed to reduce substantially the double taxation of corporate-source income by eliminating investor-level taxes on dividends paid from earnings on which corporate tax has been paid. However, the congress approved a quite modified version of the proposed (Hubbard, 2005).
Strulik (2003), Naito (2006) and Peretto (2007) recognize the importance of studying the implications of taxation on economic growth. Strulik (2003) analyzes this relationship through the finance-growth channel while Naito (2006) compares the effects of tariff reform with tax reform in an open economy framework. Brita et al. (2012) analyzes the effects of streamlining the VAT system in a general equilibrium framework. Peretto (2007) studies the effect of different tax reforms in a growth model and concludes that subsidizing R&D, eliminating corporate taxes or reducing consumption or labor taxes would be welfare-improving and the endogenous increase in the tax on dividends necessary to balance the budget has a positive effect on growth. However, Peretto (2007) does not present any quantitative exercise as we do. There are recent attempts to evaluate quantitatively welfare effects of policies in endogenous growth models. Grossmann et al., 2010 and Grossmann et al., 2013 evaluate welfare effects of policies that usually are not neutral to the deficit. Gómez and Sequeira (2013) examine the growth and welfare effects of budget-neutral subsidy policies, finding significant welfare effects of increasing subsidies to R&D and implementing optimal subsidies policies. However none of the previous articles study the growth and welfare effects of streamlining the tax system, namely of taxing only consumption, of taxing only income, or eliminating double taxation on capital income and, additionally, maintaining a balanced government budget. We fill this gap. To this end, we use the endogenous growth model with elastic labor supply developed by Gómez and Sequeira (2013). Given our focus on the revenue side, we allow for the double taxation of profits at the corporate and the personal levels that are present in the US tax system. Thus we enrich the tax code to introduce a tax on dividends, as well as a tax on capital gains, and implement several new tax-reform budget-neutral experiments. Thus, our contribution is quantitative. Our focus on policy-reforms that do not influence deficits guarantee the practical interest of our experiments. This quantitative evaluation has obvious policy interest as it may indicate to politicians the way of streamlining tax systems without harming the government deficits. The next Section presents the model and briefly describes equilibrium, transitional dynamics and calibration. Section 3 presents the main growth and welfare results from tax reforms, including a sensitivity analysis subsection, and Section 4 concludes.
We complement the existing literature by presenting numerical exercises to evaluate the effect of streamlining the US tax-system. Using an endogenous growth model with physical capital, human capital and R&D, which consider leisure choice as well as several externalities, we find that significant welfare and growth gains could be obtained from switching to a consumption-based tax system. Eliminating the double taxation of firms' profits at the corporate and personal levels could also yield noticeable welfare gains without compromising the government budget. A complete sensitivity analysis shows the robustness of these conclusions. Those results should have policy implications on the decisions to adopt tax-reforms in the US which streamline the corporate income taxation and that base the system more on consumption than in income.
