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A number of recent proposals for fundamental tax reform would replace the current federal income tax system with a comprehensive consumption-based tax. Objectives of tax reform include stimulating economic activity and promoting a more efficient allocation of resources. Many common features of recent proposals could achieve those results--for example, a broader tax base, more uniform rates, and a tax on consumption rather than income.

This Congressional Budget Office (CBO) study analyzes the major economic effects of several tax reform plans and finds that much uncertainty surrounds the likelihood and magnitude of the economic gains from tax reform. The study focuses on the effects on saving and investment, output, and the allocation of resources within the economy, as well as the ultimate impacts of those changes on social well-being. The study was prepared at the request of Senators Pete Domenici, Robert Bennett, Joseph Biden, and Robert Kerrey and former Senator Sam Nunn.

The analysis was carried out by Diane Lim Rogers of CBO's Tax Analysis Division under the direction of Rosemary Marcuss and Frank Sammartino and by Joyce Manchester of CBO's Macroeconomic Analysis Division under the direction of Robert Dennis and Doug Hamilton. John Sturrock of the Macroeconomic Analysis Division was the internal reviewer and, along with Frank Sammartino and Doug Hamilton, made extensive contributions to the study. Additional comments were provided by Leonard Burman, Kim Kowalewski, Benjamin Page, William Randolph, Pearl Richardson, John Sabelhaus, Kent Smetters, and Roberton Williams of CBO. Outside comments and suggestions on the study came from Alan Auerbach, Barry Bosworth, and David Bradford.

Paul L. Houts edited the report, and Chris Spoor provided editorial assistance. Simone Thomas produced drafts of the report with assistance from Dorothy Kornegay and Linda Lewis Harris. Kathryn Quattrone and Jill Sands prepared the report for publication.
 

June E. O'Neill
Director
July 1997
 
 

SUMMARY

ONE - INTRODUCTION

• Taxing the Returns from Saving, Investment, and Work
• How to Get There from Here: The Significance of Transition
• Evaluating Comprehensive Tax Reform

TWO - RECENT TAX REFORM PROPOSALS

• An Overview of the Alternatives
• Common Elements of Recent Proposals for Comprehensive Tax Reform

THREE - EFFECTS ON THE MACROECONOMY

• The Effect of Tax Reform on Saving
• The Effect of Tax Reform on Capital Flows and Domestic Investment
• The Effect of Tax Reform on Labor
• The Effect of Tax Reform on Economic Output
• The Effect of Tax Reform on Interest Rates
• Conclusion

FOUR - EFFECTS ON THE ALLOCATION OF RESOURCES

• The Effect of Tax Reform on Incorporation, Asset Mix, and the Cost of Capital
• The Effect of Tax Reform on the Use of Capital and Labor
• The Effect of Tax Reform on Financial Decisions
• The Effect of Tax Reform on Other Sectors of the Economy
• Conclusion

FIVE - EFFECTS ON ECONOMIC EFFICIENCY

• Economic Efficiency and Tax Policy
• Would a Switch to a Consumption-Based Tax Enhance Economic Efficiency?
• Estimating the Gains in Efficiency from a Proportional Consumption-Based Tax
• What Accounts for the Gains in Efficiency from a Proportional Consumption-Based Tax?
• Evidence from Other Studies
• Conclusion

APPENDIXES

A - What Will a Consumption-Based Tax Do to the Price Level and the Value of Existing Assets?
B - Simulation Models and the Saving Response
C - The Fullerton-Rogers General-Equilibrium Model
 

TABLES
1.	Comparing Individual-Level Taxes Under Current Law and Alternative Proposals
2.	Comparing Business-Level Taxes Under Current Law and Alternative Proposals
3.	Allocation of Types of Capital by Industry and Sector
4.	Impact of a Consumption Tax on Effective Tax Rates and Allocation of Capital, by Sector and Type of Capital
5.	Changes in Industries' Output Levels and Capital Intensity from a Switch to a Proportional Consumption Tax
6.	Debt as a Percentage of Capital Stock
7.	Tax Rates Associated with a Switch to a Proportional Consumption Tax
8.	Comparing Gains in Efficiency from a Broad-Based Proportional Consumption Tax and a Wage-Based Income Tax
9.	Comparing Gains in Efficiency Under Various Consumption Tax Bases
10.	Comparing Gains in Efficiency Under Consumption and Income Tax Bases
11.	Comparing Gains in Efficiency from a Proportional Value-Added Tax Under Current Law and Gains Before the Tax Reform Act of 1986
BOXES
1.	Comparing Taxes on Savings Under an Income Tax and Various Types of Consumption Taxes
2.	Destination-Based Versus Origin-Based Taxes
3.	The Effect of Tax Reform on Rates of Return
4.	Using the Fullerton-Rogers Model to Predict Changes in the Allocation of Resources
5.	Calculating Gains in Efficiency
B-1.	A Key Factor in the Simulation Models: The Intertemporal Elasticity of Substitution

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