Is a Consumption Tax Equivalent to a Wage Tax?

Abstract

Is a consumption tax equivalent to a wage tax? This article examines this question in a two-period life-cycle model with Cobb-Douglas production and utility functcons. Three taxes are compared: income, wage, and consumption. The article shows how equivalence depends crucially on government debt policy. If the government varies the government-debt/capital-stock ratio so that each tax achieves the same steady-state capital per worker, then the consumption tax is equivalent to the wage tax: The representative individual chooses the same consumption path and attains the same lifetime utility. However, if the government maintains the same debt/capital ratio under the three taxes, then the consumption tax is not equivalent to the wage tax: The consumption tax achieves a higher capital per worker than the income tax, while the wage tax achieves a lower capital per worker, and the representative individual chooses a different consumption path under all three taxes. Economists should therefore indicate the crucial role of government debt policy in any discussion of tax equivalence.