Gustavo Ventura (Arizona State University)

The Looming Fiscal Reckoning: Tax Distortions, Top Earners and Revenues

joint with Nezih Guner and Martin Lopez-Daneri

Abstract.  How should the U.S. confront the growing revenue needs driven by higher spending across the board? We investigate the mix of potential tax hikes that minimize welfare costs under several tax options and evaluate their impact on macroeconomic aggregates. We do so in the context of a life-cycle growth model that captures key aspects of the earnings and wealth distributions and that explicitly considers the non-linear shape of taxes and transfers in place. We evaluate changes in income taxes, the intro- duction of an economy-wide linear consumption tax, and a wealth tax for top wealth holders that match different revenue targets. Our findings show that a progressive consumption tax (a linear tax combined with transfers) and a reduction in income tax progressivity consistently emerge as the best alternative to minimize welfare costs associated with a given need for revenue. A 30% long-run requirement of additional Federal revenue requires a consumption tax rate of 27.8%, a transfer of about 12% of benchmark household income to all households, and a reduction of top marginal income tax rates of more than 5 percentage points. Output declines by about 7.9% in the long run.