(When) is consumption taxation equivalent to wage taxation?

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Abstract

This article deals with the question of the equivalence between consumption taxation and wage income taxation. It is argued that when individuals behave according to strict life-cycle reasons, these taxes are not equivalent in either of the standard senses. Although a balanced-budget increase in the wage tax unambiguously decreases the steady-state capital-labor ratio, a balanced-budget increase in the consumption tax may have any impact on long-run capital accumulation. A differential incidence shift from wage to consumption taxation is associated with a higher value of the steady-state capital-labor ratio and increases welfare when the starting point is a dynamically efficient steady state. However, in the presence of intergenerational altruism, consumption and wage taxes are structurally equivalent (i.e., both in balanced-budget terms and under a differential incidence approach). An increase in any of them entails no effect on the steady-state capital-labor ratio and welfare level, with the only consequence of transferring resources away from the private sector and to the government.
Original languageEnglish
Pages (from-to)83-101
JournalPublic Finance Review
Volume25
Issue number1
DOIs
Publication statusPublished - 1 Jan 1997

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