MOVING TO A DIRECT TAX ON CONSUMPTION: SOME TRANSITIONAL ISSUES

The thesis shows two possible ways in which intergenerational redistributions associated with a reform from a comprehensive income tax to a direct consumption tax are affected when the standard models studying this phenomenon are extended.; The usual models studying the welfare impact of a direct consumption tax reform on transitional generations use numerically simulated overlapping generation general equilibrium models with strict life-cycle savers and a single production sector. The models examine the welfare impact of moving from a comprehensive income tax to either an expenditure tax or a wage tax; business taxes are ignored and assumed to "pass through" to individuals. One important result of these studies is that the expenditure tax reform results in large steady state welfare gains at the cost of imposing substantial welfare losses on the initial elderly generations. In marked contrast, a wage tax reform creates welfare gains to the elderly generations but results in lower steady state welfare gains (or even losses). This thesis tests the robustness of these conclusions under two important conditions ignored by these models.; First, the thesis incorporates an explicit business sector in these models and studies the impact of implementing the two above described consumption taxes with an additional reform of replacing the business income tax with a business cash flow tax. Intergenerational redistributions are altered and difference in steady state welfare gains are much smaller under such consumption tax reforms.; Second, the thesis shows how practically feasible transition rules can lower intergenerational redistributions without affecting the final steady state values. A variety of transition rules, both in business and individual sectors, are studied in this context.