Does Old Capital Matter for Implementing a Pareto-Improving Tax Reform?

Abstract

The proposal to replace income taxes by consumption taxes is a recurrent theme in the political debate. Such a reform has two effects. First, both taxes induce different static distortions. The consumption tax does not affect the consumption-savings margin, but with a given revenue requirement, it must distort the labor supply decision more severely than the income tax does. Second, in a dynamic environment, a switch to the consumption tax induces an implicit lump-sum levy on existing wealth. The resulting efficiency gain, however, implies an intergenerational redistribution at the expense of older individuals.