By Kilian Ruppert, Mattias Schön and Nikolai Stähler
This paper assesses how a permanent shift from financing a public pay-as-you-go pension by direct (labour income) taxation towards financing it by indirect (consumption) taxation affects the economy and welfare. To this end, we use an overlapping-generations-augmented two-region general equilibrium framework with search frictions on the labour market. The analysed tax reform partially shifts the tax burden from domestic to foreign producers and lowers marginal costs of domestic production and generates positive domestic macroeconomic effects. In addition,the partial postponement of a household’s tax burden to retirement leads to higher savings and increases domestic assets. However, for some time after implementation of the tax reform, the policy-induced increase in consumption costs makes retirees and households close to retirement worse off. Moreover, the increase in domestic net foreign assets implies that consumption of foreign households eventually falls, which stands in contrast to what is commonly found in models without an endogenous savings motive.
Great analysis, and I am sure one can improve the scheme with 1) time-varying tax rates to smooth the transition (in the spirit of the work of Conesa and Garriga) and 2) tax some goods more than others (sin taxes dome to mind).