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National Retail Sales Tax: What would be the effect on economic growth?

In theory, moving to a national retail sales tax would provide additional avenues for economic growth. Estimates using plausible assumptions suggest that if a relatively pure version of such a tax were effectively implemented, the growth effects would be positive but modest, especially over the first ten years or so.

  • Changing the tax base from income to consumption enhances the after-tax return to saving and investment. More saving and investment results in a larger capital stock, which improves workers’ productivity and raises output. The double taxation of previously existing assets during the transition to a national retail sales tax would allow for lower rates on the rest of the tax base, and thus would encourage additional growth.
  • However, the world is not that simple. Many forms of saving-including all pensions and 401(k) plans and most Individual Retirement Accounts-already receive consumption tax treatment, and many forms of corporate income are not taxed at all. Moreover, under a national retail sales tax the transitional rules governing existing assets could reduce the effect on saving further.
  • A number of analysts have constructed models capable of generating realistic estimates of the impact of fundamental tax reform on growth. The most complete model, developed by David Altig and colleagues, shows the effects of moving from the current system to a flat-rate consumption tax. Their analysis of such a reform, which assumes a less generous demogrant than proposed by national retail sales tax advocates, transition relief for existing assets, and no avoidance or evasion of the new tax, finds that the economy would be 0.6 percent larger than otherwise after two years, 1.8 percent larger after ten years, and 3.6 percent larger in the very long run. Plausible allowances for avoidance, evasion, and the incorporation of a more generous demogrant would reduce these already modest estimates.
  • It appears on both conceptual and empirical grounds that switching to a national retail sales tax would raise consumer prices, with several economic effects. First, anyone holding nominal (that is, non-inflation-protected) financial assets-such as balances in saving accounts, CDs, or bonds-would see a drop in the value of those assets. Conversely, issuers of nominal debt, including the government, would see a reduction in the real burden of their debt outstanding.
 
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   Entry 3 of 8