We use political-equilibrium theory and the neoclassical growth model to compare consumption and income tax systems. If government outlays are used for redistribution through transfers, then steady-state equilibria in societies that use income taxes are not necessarily worse in welfare terms, and may even be better. Income taxes are attractive precisely because they are more distortionary, since this implies low equilibrium transfer levels. We also find that switching tax systems typically does not benefit the median voter; moreover, a change from income to consumption taxes may make everybody worse off.
Bibliographical noteFunding Information:
We thank Stephen Coate, Ellen McGrattan, Torsten Persson, and participants at seminars/conferences at the Federal Reserve Bank of Minneapolis, the Federal Reserve Bank of Richmond, the Institute for International Economic Studies, the University of Pennsylvania, the University of Rochester, the University of Toronto, Universidad de Alicante, and Universidad Carlos Ill for helpful comments. Krusell and Rios-Rull thank the National Science Foundation for financical support. The views expressed herein are those of the authors and not necessarily those of the Federal Reserve Bank of Minneapolis or the Federal Reserve System.
- Consumption taxes
- Income taxes
- Political equilibrium