CONSUMPTION TAXES: MACROECONOMIC EFFECTS AND POLICY ISSUES

          Proposals for reform of the federal tax code often receive attention from the business press, economic analysts and the public, with a consumption tax being an alternative that is often suggested.

          Alan Garner, assistant vice president and economist at the Federal Reserve Bank of Kansas City, examines the potential macroeconomic impacts of a such a move in “Consumption Taxes: Macroeconomic Effects and Policy Issues.” The article is featured in the second quarter edition of the Economic Review.

          Garner explores three widely discussed versions of a consumption tax: a national retail sales tax, a value-added tax and a consumption-type flat tax. He finds that all three proposals could raise U.S. output over the long run, but such reforms could have sizable transition effects as well, creating challenges for monetary policymakers.

          Consumption and income taxes have different incentives to save and invest. A consumption tax is more likely to encourage savings because the tax does not penalize savers while an income tax places a higher burden on savers because households pay their tax on taxable income with no deduction for new saving. The capital income received from the new saving will also be taxed as a part of current capital income in some future period.

          Although a consumption tax offers a greater incentive for savings, it also would raise a variety of difficult issues, such as the effect on the income distribution and the value of existing assets. The move to a consumption tax might also create short-run challenges for monetary policymakers who might have to respond to anticipatory consumer behavior and changing financial asset prices.
 

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