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The Design of a Consumption Tax under Capital Risk

Author

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  • Syed M. Ahsan
  • Peter Tsigaris
Abstract
This paper focuses on the design of a consumption tax in a world of capital risk. The certainty literature discusses two standard options, namely the cash flow method and the pre-payment method (i.e., the wage tax), and finds the two approaches to be equivalent. Models that consider capital risk (via asset choice) reach different conclusions. This discrepancy arises in part due to a different choice of the social discount rate. In light of the failure of the discount rate argument to resolve the issue at hand, we explore the market certainty equivalence of risky government revenue. We let revenue risks stay in the private sector, and examine the market value of the feasible transfer (e.g., in the form of a public good) back to households. We reach three broad conclusions. First, we find that if the state returns to each household its own tax revenue risks, equivalence will be re-established as in certainty models. Next, we show that if the state engages in intergenerational risk sharing (e.g., through a system of stochastic tax-transfers), the wage tax cannot be construed to be a valid pre-payment alternative to the cash flow or a modified wage taxation system. Efficient risk allocation across generations under a cash-flow tax (or, one that includes future captial gains as well as wages in the tax base) leads to a Pareto improvement over the simple wage tax. Finally, a major policy implication follows; in order to be practicable, a consumption tax would have to be implemented via registered savings accounts much in the fashion of the Canadian RRSP program rather than through the pre-payment route.

Suggested Citation

  • Syed M. Ahsan & Peter Tsigaris, 1998. "The Design of a Consumption Tax under Capital Risk," CESifo Working Paper Series 163, CESifo.
    • Handle: RePEc:ces:ceswps:_163
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    References listed on IDEAS

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    2. Ahsan, Syed M., 1989. "Choice of tax base under uncertainty : Consumption or income?," Journal of Public Economics, Elsevier, vol. 40(1), pages 99-134, October.
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    18. George R. Zodrow, 2019. "Taxation, Uncertainty and the Choice of a Consumption Tax Base," World Scientific Book Chapters, in: George R Zodrow (ed.), TAXATION IN THEORY AND PRACTICE Selected Essays of George R. Zodrow, chapter 8, pages 227-237, World Scientific Publishing Co. Pte. Ltd..
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    Cited by:

    1. Spencer Bastani & Sebastian Koehne, 2022. "How Should Consumption Be Taxed?," CESifo Working Paper Series 10038, CESifo.
    2. Paolo M. Panteghini, 2009. "On the equivalence between labor and consumption taxation," Economics Bulletin, AccessEcon, vol. 29(2), pages 622-629.
    3. Syed M. Ahsan & Panagiotis Tsigaris, 2009. "The Efficiency Loss of Capital Income Taxation under Imperfect Loss Offset Provisions," Public Finance Review, , vol. 37(6), pages 710-731, November.
    4. Hans-Werner Sinn, 1999. "Inflation and Welfare: Comment on Robert Lucas," NBER Working Papers 6979, National Bureau of Economic Research, Inc.
    5. Ira Horowitz & R. Horowitz, 1999. "Risky Assets and the Choice of Tax Base," Public Finance Review, , vol. 27(5), pages 467-480, September.
    6. Syed M. Ahsan & Panagiotis Tsigaris, 2011. "The Utility Compensated Effects of a Wage Tax on Human Capital and Consumption Decisions," Public Finance Review, , vol. 39(4), pages 571-593, July.
    7. Syed Ahsan & Panagiotis Tsigaris, 2002. "Measuring the Social Discount Rate under Uncertainty: A Methodology and Application," CESifo Working Paper Series 824, CESifo.
    8. Dirk Schindler, 2008. "Taxing Risky Capital Income - A Commodity Taxation Approach," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 64(3), pages 311-333, September.
    9. Syed M. Ahsan & Panagiotis Tsigaris, 2003. "Choice of Tax Base Revisited: Cash Flow vs. Prepayment Approaches to Consumption Taxation," CESifo Working Paper Series 983, CESifo.

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    More about this item

    Keywords

    Cash Flow Tax; Risky State Revenue; Intergenerational Risk Sharing;
    All these keywords.

    JEL classification:

    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • H63 - Public Economics - - National Budget, Deficit, and Debt - - - Debt; Debt Management; Sovereign Debt

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