Flat Tax Reforms in the U.S.: A Boon for the Income Poor

Summary: This article quantifies the aggregate, distributional and welfare consequences of two revenue neutral flat-tax reforms. We use a version of the neoclassical growth model economy that is able to reproduce the U.S. distributions of earnings and wealth in very much detail. In the less progressive reform the households face a 22 percent integrated flat tax and a labor income tax exemption of $16,000 per household. In the more progressive reform the flat-tax rate is 29 percent and the labor income tax exemption is $32,000 per household. We find that while the less progressive reform is expansionary (output increases by 2.4 percent) and results in a more unequal distribution of income after taxes, the less progressive reform is contractionary (output decreases by 2.6 percent) and is significantly more egalitarian. We find that equality wins the trade-off: in the less progressive reform aggregate welfare falls by −0.17 percent of consumption, and in the more progressive reform it increases by +0.45 percent of consumption. Both flat-tax reforms result in significant boons for the income poor who pay less income taxes and obtain sizeable welfare gains