Progressive Consumption Taxes

In a static setting, whether consumption or labor income is progressively taxed isirrelevant for household choices and welfare. In a dynamic setting, however, thesetwo forms of progressivity have markedly di erent implications for how earnings varyalong the life-cycle: in a stylized life-cycle model, the progressive income tax acts reducingFrisch elasticities of labor supply whereas the progressive consumption taxacts reducing the elasticity of intertemporal substitution. After showing that the latterleads to fewer inefficiencies in the stylized model than the former, we explore theconsequences of replacing the current U.S. tax system by one in which labor incomeare linear and consumption taxes are progressive. We nd welfare gains that exceed10% in consumption equivalent variation terms for all possible speci cations in steadystatecomparisons. Welfare gains are attained in all our speci cations with either verysmall increases in the capital stock or even large declines