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Overselling the Economic Efficiency Gains from Shifting the Tax Mix Towards Consumption Taxes

PFM, Vol. 17 No. 3, (2017)

It is frequently argued that it would be beneficial to move the tax mix towards greater reliance on consumption taxes, with offsetting reductions in income taxes. Proponents argue that this would increase the incentives to “work, save, and invest” and would help improve productivity growth. In Canada, policy experts have generally advocated shifting the tax mix towards con-sumption. However, on a number of occasions when such a choice was put to the electorate, this shift was rejected.

In fact, when one looks at the empirical research on response elasticities, it suggests that the net positive impacts are likely to be relatively small. The most reliable estimates from economic models indicate a small positive impact on economic efficiency from changing the tax mix. The largest and clearest impact of changing the tax mix is on the distribution of income, as the income tax is much more susceptible to being progressive.

Therefore, the positive impact on overall GDP would be too small to compensate most taxpay-ers. Middle income earners in particular are likely to be net losers from changes in the tax mix. Designing changes in the tax mix so as to make everybody better off is a complex task. Voters seem to be aware of the income distribution impacts, and vote in their own self-interest. In a refer-endum in the province of British Columbia, the majority voted to repeal a value added tax. The percentage voting for repeal was highest in the lowest income electoral districts.

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