A Progressive Consumption Tax: An Important Instrument for Stabilizing Business Cycles, or Just an Exotic Idea?

ABSTRACT

We introduce progressive consumption taxation into a real-business-cycle setup augmented with a detailed government sector. We calibrate the model to Bulgarian data for the period following the introduction of the currency board arrangement (1999–2016). We investigate the quantitative importance of the presence of progressive taxation of consumption expenditures for the stabilization of cyclical fluctuations in Bulgaria. We find the quantitative effect of such a tax to be very small, and thus not important for either business cycle stabilization or public finance issues.

KEYWORDS:

• business cycles
• progressive consumption taxation
• Bulgaria

JEL CLASSIFICATION CODES:

• E24
• E32

Disclosure Statement

No potential conflict of interest was reported by the authors.

Notes

^1. Varga (2014) is the most recent theoretical treatment. Her analysis is partial equilibrium, and not based on intertemporally optimizing consumers.

^2. A tax on investment is like a tax on capital, as it taxes the newly created capital stock.

^3. Government also does not pay it—or pays it, and then reimburses itself, or subsidizes itself through the use of a lump-sum tax.

^4. We do not propose abolishing all income taxation with a progressive consumption tax. Exploring this is left for future research.

^5. This utility function is equivalent to a specification with a separable term containing government consumption, e.g., Baxter and King (1993). Since in this article we focus on the exogenous (observed) policies, and the household takes government spending as given, the presence of such a term is irrelevant. For the sake of brevity, we skip this term in the utility representation just presented.

^6. Note that by choosing $corr(n_t,w_{t-k})$ the household is implicitly setting investment $corr(n_t,w_{t-k})$ optimally.

^7. In this article we abstract away from administration costs and evasion issues. We abstract away from inequality aspects of progressive taxation as well. In the model, the consumption tax schedule is akin to ad valorem tax on imports in international trade literature; the difference is that the tax is being levied on domestically consumed final goods. Furthermore, many countries even have multiple, differentiated VAT rates.

^8. It should be evident that the progressivity of consumption taxation does not affect tax revenue in the steady state.

^9. This corresponds to the degree of progressivity of the income tax schedule during the period 1993–2007 in Bulgaria.

^10. The model-predicted 95% confidence intervals are available upon request.

^11. Following Canova (2007), this is used as a goodness-of-fit measure.