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Growth Effects of Shifting from a Graduated-rate Tax System to a Flat Tax

Authors

  • Steven P. Cassou,

    1. Cassou: Associate Professor, Department of Economics, Kansas State University, 327 Waters Hall, Manhattan, KS 66506. Phone 1–785–532–6342, Fax 1–785–532–6919, E-mail scassou@ksu.edu
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  • Kevin J. Lansing

    1. Lansing: Senior Economist, Research Department, Federal Reserve Bank of San Francisco, P.O. Box 7702, San Francisco, CA 94120–7702. Phone 1–415–974–2393, Fax 1–415–977–4031, E-mail kevin.j.lansing@sf.frb.org
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    • *

      For helpful comments and suggestions, we thank William Gale, Greg Huffman, Kenneth Judd, Rodi Manuelli, Alvin Rabushka, B. Ravikumar, Ben Russo, and participants in the CEPR/Tilburg University Conference on Dynamic Aspects of Taxation, Tilburg, 8–10 September 2000. Part of this research was conducted while Lansing was a national fellow at the Hoover Institution, whose hospitality is gratefully acknowledged.


Abstract

We compute the growth effects of adopting a revenue-neutral flat tax for both a human capital–based endogenous growth model and a standard neoclassical growth model. Long-run growth effects are decomposed into the parts attributable to the flattening of the marginal tax schedule, the full expensing of physical-capital investment, and the elimination of double taxation of business income. The most important element of the reform is the flattening of the marginal tax schedule. Without this element, the combined effects of the other parts of the reform can actually reduce long-run growth. In the years immediately following the reform, the transition dynamics implied by the neoclassical growth model are quite similar to that of the endogenous growth model. (JEL E62, H21)

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