Labour or consumption taxes? An application with a dynamic general equilibrium model with heterogeneous agents

This study analyzes the effects of tax reform that shifts tax burden from labour to consumption. In this context, I also deal with the issue of progressivity. Even though this kind of tax policy change has recently gained popularity, its positive effects are debatable while the offsetting effect of a consumption tax on labour supply makes the net welfare change rather ambiguous.I examine these effects using a dynamic general equilibrium model with heterogeneous agents. The model iscalibrated to fit certain characteristics of theFinnish economy. In addition to efficiency effects, I study the tax reform’s effect on income and wealth distribution. First, I find that eliminating progressivity in labour taxationincreases efficiency viaincrease in capital accumulation that comes, however, in expense of slightly more inequality. Then, tax reform that replaces progressive labour taxes with a flat-rate consumption tax leads to a significant rise in capital accumulation, a negligible change inlabour supply and gross labour income distribution, buta relatively considerable increase in wealth concentration.