Consumption Taxes: Macroeconomic Effects and Policy Issues

Proposals for fundamental reform of the federal tax code are receiv-ing increased attention in the business press and among economicanalysts and policymakers. President Bush has identified tax reform as a top priority, calling for a tax system that is “pro-growth, easy to understand, and fair to all. ” Moreover, the President has appointed a commission to consider different approaches to tax reform. One approach might be to improve the current income-based federal tax code, perhaps by broadening the tax base and lowering income-tax rates. However, another approach might be to replace current income taxes altogether with a consumption tax. Switching the federal tax system from an income tax to a consump-tion tax could have important macroeconomic effects. Most economists believe that switching to a consumption tax could increase saving and real output per person over the long run, although studies differ on the size of these effects. However, switching to a consumption tax might also require sizable short-run economic adjustments and create chal-lenges for monetary policymakers.