This paper uses a new, large-scale, dynamic life-cycle simulation model to compare the welfare and macroeconomic effects of transitions to five fundamental alternatives to the U.S. federal income tax, including a proportional consumption tax and a flat tax. The model incorporates intra-generational heterogeneity and a detailed specification of alternative tax systems. Simulation results project significant long-run increases in output for some reforms. For other reforms, namely those that seek to insulate the poor and initial older generations from adverse welfare changes, long-run output gains are modest.
Fundamental tax reform has been a hot issue, and for good reason. The U.S. tax system – a hybrid of income- and consumption-tax provisions – is complex, distortionary, and replete with tax preferences. Recent “reforms” of the tax code, including the Taxpayer Relief Act of 1997, have made the system even more complex and buttressed the argument for fundamental reform.
“Fundamental tax reform” means different things to different people. The definition adopted below is the simplification and integration of the tax code by eliminating tax preferences and taxing all sources of capital income at the same rate. Several current tax proposals certainly deserve to be called “fundamental.” They include Hall and Rabushka's (1983, 1995) flat tax, the retail sales tax, and Bradford's (1986) X tax. The flat tax and the retail sales tax are two alternative ways of taxing consumption.