A DISTRIBUTIONAL ANALYSIS OF AN ENVIRONMENTAL TAX SHIFT: A Retail Sales Tax Reform 4

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Next I consider a more modest tax reform that is more comparable to the environmental tax reforms considered in the last section. A broadbased sales tax is imposed with a rate sufficiently high to raise $125 billion in revenue. The revenue is used to lower taxes as described in the first scenario (Table 6). Based on the annual income analysis, the tax reform is regressive with the lowest 30 percent of the income distribution along with the top 10 percent facing tax increases. Across decile tax shifts exceed one percent of tax revenue for the groups facing a tax increase. The change in Suits indices shows a shift toward greater regressivity in the tax system. Under either the lifetime income measure or the cohort measure, the tax shift looks modestly progressive with the Suits Index increasing in both cases. For the cohort analysis, taxes fall for all but the top 20 percent of the income distribution. Using the lifetime income measure, taxes fall for the 10th through 80th percentiles. The lowest decile faces a .3 percent increase in average tax rates.

If the desire in tax reform is to maintain or increase the progressivity of the tax system, it appears from this analysis that environmental tax reforms may be more effective than a comprehensive consumption tax reform. The differences between a ten percent shift to consumption tax versus a cluster of environmental taxes is much smaller. Focusing on the bottom of the distribution, the environmental taxes do not increase the tax burden for the lowest income decile as much as the consumption tax reform (using annual or lifetime income measures). A smaller fraction of the taxes collected are shifted onto the top decile, however, under the environmental taxes (0.5 percent versus 1.7 percent for the sales tax).

This paper has only focused on distributional considerations. Whether efficiency gains are greater under environmental than consumption tax reforms is an issue that I have not addressed in this paper. For environmental reforms, one efficiency gain is the closer alignment of marginal social costs with marginal social benefits in the use of pollution related inputs and goods. A second issue is the degree to which the efficiency distortions which arise from price changes in the face of pre-existing tax distortions are greater or less than distortions that can be reduced by lowering other taxes.