{
  "id": "98-901",
  "type": "CRS Report",
  "typeId": "REPORTS",
  "number": "98-901",
  "active": false,
  "source": "EveryCRSReport.com",
  "versions": [
    {
      "source": "EveryCRSReport.com",
      "id": 105266,
      "date": "1998-10-30",
      "retrieved": "2016-05-24T20:49:56.349941",
      "title": "Short-Run Macroeconomic Effects of Fundamental Tax Reform",
      "summary": "Fundamental tax reform continues to receive attention from lawmakers, private advocacy groups,\nand tax analysts. Preeminent among the proposals is the replacement of the current income tax with\nsome form of a consumption tax. Much of the discussion of the merits of consumption taxes relative\nto income taxes is centered on the kinds of incentives and efficiencies that the two kinds of taxes\nexhibit in the long run. Increasingly, however, analysts have begun to explore the transition (short-\nrun) effects associated with shifting from an income tax to a consumption tax. \n  Some of these transition effects are common to all consumption tax proposals. For example,\na shift to any consumption tax would involve some sectoral dislocation, the most important of which\nwould be a shift of resources out of housing and into other sectors. All consumption tax proposals\nimpose a one time tax on existing capital, as well. In all likelihood, a shift to consumption taxes\nwould entail a temporary rise and then a decrease in interest rates.\n  Potentially more serious transition problems occur when taxes are imposed in their indirect\nform (a retail sales tax or a value-added tax). The shift from a direct tax (imposed largely on\nindividual wage-earners) to an indirect tax (imposed on businesses) could cause a significant\neconomic contraction if wages are \"sticky\" downwards, as most economists believe to be the case,\nbecause many firms would not have enough resources to pay the taxes. In this case, a one-time price\nincrease, in the neighborhood of 20 to 25 percent, would be required to allow firms to pass the tax\non to consumers and avoid a serious recession. The money supply would need to rise by a similar,\nor perhaps even larger, amount.\n  Our ability to formulate an appropriate monetary response to deal with a shock of this\nmagnitude is questionable. Not only are there considerable uncertainties about the empirical\nmagnitudes of crucial relationships needed to guide the monetary adjustment (even uncertainties\nabout the definition of money), but there are also direct effects of the tax change on variables, such\nas interest rates, that are normally used to guide monetary policy. The magnitude of these interest\nrate effects is uncertain. A transitory rise in frictional unemployment, due to sectoral shifts, would\nalso be likely. In addition, actions taken in anticipation of the tax change could cause temporary\neffects on aggregate demand and the interest rate. \n  These problems would be greatly diminished in the case of the flat tax, which is imposed as a\ndirect tax. Even in this case, there would be short-run unemployment costs associated with sectoral\ndislocations, but the shock would be less severe than in the case of the retail sales tax or value-added\ntax. However, the price rise that would be needed to avert a contraction is also the mechanism that\ncauses the lump-sum tax on old capital to be shared by debt as well as equity. Without the price\nincrease, the lump sum tax would fall only on equity capital, and could impose tax burdens that are\nlarger than net asset values in cases where assets are heavily leveraged.",
      "type": "CRS Report",
      "typeId": "REPORTS",
      "active": false,
      "formats": [
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          "encoding": null,
          "url": "http://www.crs.gov/Reports/pdf/98-901",
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      ],
      "topics": []
    }
  ],
  "topics": [
    "Economic Policy"
  ]
}