John W. Diamond

Consumption Tax Reform: Changes in Business Equity and Housing Prices

The following sections are included:IntroductionEffects on the Prices of Business AssetsEffects on the Price of Owner-Occupied HousingModel Structure and CalibrationSimulation ResultsConclusionAcknowledgmentsReferences

Economic Effects of a Personal Capital-Income Tax Add-On to a Flat Tax

Although much academic and policy discussion has focused on replacing the income tax with a consumption-based tax, very few consumption-based direct tax reforms have been enacted. Much more common are approaches that reduce the level of capital-income taxation under an income tax, including the current Nordic dual income taxes and broadly similar approaches recently proposed in Germany, Switzerland, and the United States. This paper examines the general economic case for such reforms and then reports the results of a simulation of the economic effects of implementing such a capital-income add-on tax to a flat tax structure in the U.S.

The Role of Dynamic Scoring in the Federal Budget Process: Closing the Gap between Theory and Practice

This paper discusses several issues that arise in the process of analyzing the macroeconomic effects of tax policy proposals in a way that is of practical use to legislators. In the current federal legislative process, much of the economic analysis of tax legislation boils down to a single set of numbers: an estimate of the effects of the proposal on projected federal revenues over the ten-year period following the current fiscal year. We discuss some of the practical aspects of developing a methodology for “dynamic scoring,” or accounting for potential macroeconomic effects in the estimate of the revenue effects of a specific tax proposal. While there are many areas of theoretical debate and uncertainty in modeling the macroeconomic effects of tax policy, we discuss three often-overlooked practical issues in incorporating those effects in a revenue estimate: (1) translation of the tax proposal into inputs to a macroeconomic model that capture all the features of the proposal that are likely to have an impact on the economy; (2) adjustment of the tax and revenue related equations in the macroeconomic model to account for the difference between the actual present-law Internal Revenue Code and the specifics of the tax proposal being analyzed; and (3) reconciliation of differences in definitions of income between National Income and Product Account (“NIPA”) data that macroeconomic models are typically calibrated to replicate, and the cash-basis income flows on which the present-law tax code is based. We show how the effects of proposed tax changes on GDP and revenues can vary depending on the methodologies chosen to address each of these issues.

Dynamic Overlapping Generations Computable General Equilibrium Models and the Analysis of Tax Policy: The Diamond–Zodrow Model

We examine the use of dynamic overlapping generations (OLG) computable general equilibrium (CGE) models to analyze the economic effects of tax reforms, using as a paradigm our Diamond–Zodrow (DZ) model. Such models are especially well-suited to analyzing both the short-run transitional and the long-run dynamic macroeconomic effects of tax reforms, including the time paths of reform-induced changes in labor supply, saving, and investment, as well as the redistributional effects of reforms across and within generations. We begin with a brief overview of the use of OLG-CGE models in the analysis of tax reform, focusing on the seminal contribution of Auerbach and Kotlikoff (1987). We then consider a variety of extensions of this work, including the multiple-good, multiple-individual model constructed by Fullerton and Rogers (1993), as well as the addition of open economy factors, human capital accumulation and uncertainty. Many of the applications of these models have focused on changes in capital income taxation or, more generally, the replacement of an income tax system that fully taxes capital income with a consumption-based tax system that exempts normal returns to capital, and we focus on such reforms. We describe in considerable detail the DZ model, which is characterized by 55 cohorts, 12 income groups within each cohort, four production sectors and explicit calculation of reform-induced changes in asset values. We conclude by describing numerous applications of the DZ model, ranging from incremental reforms of the income tax system including deficit-financed tax cuts to ‘fundamental tax reforms’ that involve replacing the income tax with a consumption-based tax system, to the implementation of a value-added tax imposed in addition to the income tax as a means of reducing current deficits and the national debt in the US.

Promoting Growth, Maintaining Progressivity, and Dealing with the Fiscal Crisis CGE Simulations of a Temporary VAT Used for Debt Reduction

Trade-offs between economic efficiency, growth, and distributional equity permeate economics, including discussions of tax policy and tax reform. Computable general equilibrium (CGE) modeling is one tool that is often used to estimate the magnitudes of the variables that determine the efficiency, growth, and equity properties of alternative tax reforms. In this article, we report the results of simulations of a CGE model that examines the economic and distributional effects of the enactment in the United States of a temporary value-added tax used to reduce the level of the national debt. The results suggest that such a reform is generally moderately progressive both for cohorts alive at the time of reform and for future generations, at least within the context of lifetime measures of tax burden, and that current middle-aged and elderly generations must bear a burden to confer a gain, relative to the status quo, on younger and future generations.