Revenue neutral tax reforms in a DSGE model with home production and infinitely lived agents

Abstract

The subject of this thesis is to explore the effects of two revenue neutral tax reforms on equity, efficieny and welfare of the society. In order to do this a DSGE model with infinitely lived agents and uninsurable idiosycnratic productivity shocks is constructed. This model is calibrated to match the macroeconomic aggregates and distributional statistics of the US economy in the period 2001-2008. In the benchmark model a progressive tax on income and a flat tax on consumption is levied. Next the first tax reform is applied to the model economy. With the first tax reform progressive income taxation is replaced with a revenue neutral flat income tax and the flat consumption tax is kept in place. This tax reform causes macroeconomic aggregates to increase, however due to the largely inequitable income distribution of agents in the model, total welfare of households decreases. As expected wealth distribution of the society becomes less equitable. Finally the effects of the second revenue neutral tax reform are investigated. In this tax reform, income taxation is abolished and the flat tax rate on consumption is increased to a higher rate which ensures revenue neutrality. This tax reform increases macroeconomic aggregates and total welfare of the society. As a result of this tax reform, wealth distribution of the society becomes slightly more equitable.