On The Impact Of A Tax Reform Package In Portugal

In this paper we analyze a tax reform package recently proposed in Cavaco Silva (1999). We do so in the context of a dynamic general-equilibrium model of the Portuguese economy and we focus on the efficiency, welfare, and tax revenue effects of this package. Simulation results suggest that the tax reform package would induce, over the next twenty-five years, a GDP gain of between 0.36% and 0.89%, depending on the design of the compensatory changes necessary to achieve deficit neutrality. The proposed compensatory hike in the VAT rates is, in itself, insufficient to ensure deficit neutrality. Nevertheless, the reduction in private consumption it would induce, would lead to a net welfare loss over the same time span. In this case, the tax reform package would improve efficiency at the cost of reducing welfare. If the whole package were financed exclusively through increased non-distortionary taxation or through reductions in public consumption, the welfare losses would be avoided and welfare gains of up to 0.66% could be generated. It could be argued, however, that under the current institutional constraints associated with the Stability and Growth Pact it is difficult to realistically design the financing mechanisms in a way that would avoid the efficiency-welfare trade-off.