Keshab Bhattarai1 Lecturer in Economics University of Hull, Business School Hu6 7RX, UK
Abstract Macroeconomic impacts of consumption and income taxes are higher when both of them rather than only one of them are employed to raise a fixed amount of revenue that is given back to households as transfers. Weapply a general equilibrium model to assess no tax, only consumption tax or only labour income tax policy alternatives in comparison to a benchmark economy in which both taxes apply to the consumption and labour income of a representative household in an economy. We find that switching to only consumption tax would improve efficiency while raising the target level revenue than in the mix of twotax case. These gains are about 80 percent of the no tax scenario. Taxing only on consumption to raise a given amount of revenue is better in terms of labour supply, lower optimal tax rates and level of utility of the household from consumption and leisure. Model applied to the UK also confirms that the consumption taxes have significantly lower burden than the labour income tax or of thecombination of both consumption and labour income taxes.
Key words: Fiscal Policy, Consumption tax, labour income tax JEL Classification: E62, H21
I appreciate comments from Professor Richard Green in the earlier draft of this paper but all errors and omissions are my own. The correspondence address: K.R.Bhattarai@Hull.ac.uk Phone: 01482-466483; Fax: 01482-466216.
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discussion of expansionary or contractionary fiscal policy is a serious shortcoming of the traditional ISLM model. Though there is a longstanding debate in the public finance as well as macro economics literature on relative merits and demerits of the direct and indirect taxes in terms of their incidence and impact to the tax payers (Ramsey (1927), Pigou(1947), Atkinson and Stiglitz (1976 ), Mirlees (1971), Whalley (1975), Hutton and Ruocco (1999)) very few of these studies investigate the macroeconomic impacts (Rebelo(1991))...