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

It is instructive to contrast the distributional impact of a green tax reform to a reform that is currently under discussion: a shift from income to consumption taxation. In this section, I consider a shift from the current income tax to a broad based retail sales tax. I consider two different reforms: first a replacement of the entire income tax with a national retail sales tax and then a replacement of 10 percent of the income tax with a small sales tax. This latter reform, while not under serious consideration, allows comparisons between the environmental tax reforms discussed above and the consumption tax reform discussed in this section.

The tax base for the national sales tax as modeled here is quite comprehensive. Housing services are not taxed per se but are taxed at the time of purchase of the house. The same approach is used for other durable goods. Medical services are included in the tax base as are other services. Assuming that non-profits and imputed financial services are included in the tax base, the revenue neutral tax rate would be 16.5 percent.

Annual Income Lifetime Income Married, Age 40-50
Decile Increase Decrease ДTax ДAverage Tax Rate TaxShift Increase Decrease ДTax ДAverage Tax Rate TaxShift Increase Decrease ДTax ДAverage Tax Rate TaxShift
1 3,119 337 2,782 34.49 2.4% 3,315 1,590 1,725 7.83 0.8% 5,399 1,508 3,891 19.89 2.3%
2 3,230 316 2,914 24.95 5.1% 3,962 2,504 1,458 5.33 1.5% 5,467 2,726 2,741 9.49 3.3%
3 4,115 1,044 3,071 17.54 5.3% 4,092 3,624 468 1.43 2.5% 6,220 2,822 3,398 8.34 4.1%
4 4,495 1,571 2,924 11.93 5.0% 4,996 4,261 735 1.95 0.8% 6,318 4,491 1,827 3.62 2.2%
5 5,000 3,013 1,987 6.30 3.5% 5,607 4,834 773 1.68 1.3% 8,682 4,858 3,824 6.69 4.6%
6 5,107 4,108 999 2.45 1.7% 5,610 5,398 212 0.43 0.4% 7,654 7,354 300 0.42 0.4%
7 6,679 5,050 1,629 3.47 2.8% 5,936 5,619 317 0.67 0.5% 7,635 8,001 -366 -0.48 -0.4%
8 6,551 6,813 -262 -0.38 -0.4% 6,436 7,550 -1,114 -1.75 -1.9% 9,581 9,460 121 0.15 0.1%
9 8,332 9,129 -797 -1.00 -1.4% 7,919 9,033 -1,114 -1.67 -1.9% 10,078 10,349 -271 -0.09 -0.3%
10 11,250 26,591 -15,341 -7.05 -26.6% 10,191 13,234 -3,043 -3.46 -5.3% 15,964 47,602 -31,638 -11.44 -38.4%
Д Suits Д Suits Д Suits
Suits -0.228 0.202 -0.430 -0.045 0.068 -0.113 -0.185 0.255 -0.440

Table 10 shows the distribution of a shift from the income tax to a broad based income tax using an annual income incidence approach. Based on the annual income approach, the tax reform is very regressive. Tax liabilities increase for the bottom 70 percent of the income distribution and decrease for the top 30 percent. The changes are quite substantial with the lowest income group seeing their average tax rate increase by 34 percentage points. Meanwhile the top decile’s average tax rate falls by 7 percent. Another way to measure the regressivity of the tax reform based on annual income is to note that the Suits Index falls from 0.202 (income tax) to -0.228 (retail sales tax) as a result of the reform. Given the size of the tax, the shift across deciles can be quite substantial. Each of the deciles from the 10th to the 40th percentiles faces an increase in taxes equal to 5 percent of the taxes collected under the personal and corporate income taxes. Meanwhile, the top decile enjoys a decrease in taxes equal to a quarter of tax collections.