Lifting the burden: fundamental tax reform and U.S. economic growth

NBB WORKING PAPER No. 21- MAY 2002

N A T I O N A L B A N K O F B E L G I U M

WORKING PAPERS - RESEARCH SERIES

LIFTING THE BURDEN: FUNDAMENTAL TAX REFORM

AND U.S. ECONOMIC GROWTH

_______________________________

Dale W. Jorgenson

(

*

)

Kun-Young Yun(**)

The views expressed in this paper are those of the authors and do not necessarily reflect

the views of the National Bank of Belgium.

(

*

)

_{Department of Economics, Littauer Center, Littauer 122; Harvard University; Cambridge USA.}

(**)

NBB WORKING PAPER No.21 - MAY 2002

Editorial Director

Jan Smets, Member of the Board of Directors of the National Bank of Belgium

Statement of purpose:

The purpose of these working papers is to promote the circulation of research results (Research Series) and analytical

studies (Documents Series) made within the National Bank of Belgium or presented by outside economists in seminars,

conferences and colloquia organised by the Bank. The aim is thereby to provide a platform for discussion. The opinions

are strictly those of the authors and do not necessarily reflect the views of the National Bank of Belgium.

The Working Papers are available on the website of the Bank:

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Individual copies are also available on request to:

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Reproduction for educational and non-commercial purposes is permitted provided that the source is acknowledged.

ISSN: 1375-680X

NBB WORKING PAPER No. 21- MAY 2002

Abstract

This paper presents a comprehensive treatment of the cost-of-capital approach for

analyzing the economic impact of tax policy. This approach has provided an intellectual

impetus for reforms of capital income taxation in the United States and around the world.

The most dramatic example is the Tax Reform Act of 1986 in the United States. In this

landmark legislation the income tax base was broadened by wholesale elimination of tax

preferences for both individuals and corporations. Revenues generated by base

broadening were used to finance sharp reductions in tax rates at corporate and individual

levels.

The cost-of-capital approach presented in this paper shows that important opportunities

for tax reform still remain. This approach suggests two avenues for reform. One would

retain the income tax base of the existing U.S. tax system, but would equalize tax burdens

on all forms of assets as well as average and marginal rates on labor income. Elimination

of differences in the tax treatment of all forms of assets would produce gains in efficiency

comparable to those from the Tax Reform Act of 1986. Equalization of marginal and

average tax rates on labor income would more than double these gains in efficiency.

Proposals to replace income by consumption as a tax base were revived in the United

States during the 1990's. The Hall-Rabushka Flat Tax proposal would produce efficiency

gains comparable to those from equalizing tax burdens on all forms of assets under the

income tax. However, a progressive National Retail Sales Tax, collected on personal

consumption expenditures at the retail level, would generate gains in efficiency exceeding

those from the Flat Tax by more than 50 percent! Equalizing marginal and average rates

of taxation on consumption would double the gains from the Flat Tax.

Editorial

On May 27-28, 2002 the National Bank of Belgium hosted a Conference on

"New

views on firms' investment and finance decisions"

. Papers presented at this

conference are made available to a broader audience in the NBB Working Papers

no 21 to 33.

NBB WORKING PAPER No. 21- MAY 2002

TABLE OF CONTENTS:

INTRODUCTION ...1

TAX REFORM PROPOSAL ...6

MODELING THE TAX REFORM PROPOSAL ...9

WELFARE IMPACTS OF FUNDAMENTAL TAX REFORM ...17

CONCLUSION...27

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