This paper examines the transitional losses that may follow conversion from an income tax to a consumption tax, even when conversion eventually raises steady-state lifetime welfare. Two recent studies have left the impression that the transitional losses would be large. Using a life-cycle growth model, this paper examines two reasons why these studies have probably overestimated the transitional losses. The model computes the welfare gains and losses of each age cohort along the transition path. It is shown that the greater the bequest motive and subjective discount rate generating the particular initial income tax steady state, the smaller would be the transitional losses. Similarly, a policy of age phasing would reduce the losses. The results demonstrate the importance of examining the transition path whenever a policy change alters capital accumulation.

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A tax-based incomes policy (TIP) is an innovative approach to the inflation-unemployment dilemma. First proposed by Sidney Weintraub and Henry Wallich, a TIP has recently begun to receive serious attention from economists (see Weintraub and Wallich, and Arthur Okun and George Perry). A TIP would provide a tax incentive for the employer, and/or employees, at each firm to reduce the size of the firm's wage increase. Elsewhere (1978a) I have examined the issues bearing on the optimal design of a TIP. In this paper, I will attempt to clarify the role of TIP by focusing on two important aspects: 1) the micro-economic rationale for TIP and 2) the compatibility of TIP with the monetary view of inflation.

In a recent paper, Lawrence Summers (1981) analyzes alternative taxes in a life cycle growth model. This paper extends his analysis to include bequests and inheritances. This inclusion is worth undertaking for several reasons. First, several recent empirical studies have suggested that bequests may account for an important share of the capital stock (Laurence Kotlikoff and Summers, 1981). Second, it is important to explore whether the comparison of taxes is significantly affected when a bequest motive is introduced. Third, the treatment of bequests under a consumption tax is controversial. The endowment rationale calls for treating a bequest as taxable consumption by the deceased (Peter Mieszkowski, 1980); the wage rationale calls for exempting bequests if such exemption raises the steady-state capital intensity and real wage (my 1980 article). This paper confines itself to positive analysis of steady states. Transition paths, and normative implications, are explored elsewhere (see my 1982 paper).

A tax-based incomes policy (TIP) is a tax incentive that tries to induce employers and/or workers to reduce and/or price increases. It is intended as a complement to the basic anti-inflation policy of gradual monetary deceleration and fiscal restraint. Its purpose is to reduce the capital stock and output loss that would otherwise accompany such a policy (see my 1978, 1979a articles). This article is divided into two sections. Section I examines the capital stock and output loss under monetary deceleration that is uncomplemented by TIP. This loss is due primarily to wage growth inertia, a central feature of modern capitalist economies. Such inertia provides not only the rationale for a TIP on increases; but also implies that special effort is required to assure that the design of a complete TIP package is fair to labor. Section II analyzes the tradeoffs confronting two alternative methods of making TIP more equitable to labor: profit and/or price restraint insurance; and a TIP on price increases of the largest firms. The original TIP, limited to increases, at first glance is often perceived as unbalanced and inequitable. This section tries to contribute to the development of a balanced equitable TIP.

This paper examines the transitional losses that may follow conversion from an income tax to a consumption tax, even when conversion eventually raises steady-state lifetime welfare. Two recent studies have left the impression that the transitional losses would be large. Using a life-cycle growth model, this paper examines two reasons why these studies have probably overestimated the transitional losses. The model computes the welfare gains and losses of each age cohort along the transition path. It is shown that the greater the bequest motive and subjective discount rate generating the particular initial income tax steady state, the smaller would be the transitional losses. Similarly, a policy of age phasing would reduce the losses. The results demonstrate the importance of examining the transition path whenever a policy change alters capital accumulation.

The authors investigate the consequences of a permanent unphased increase in the U.S. gross saving rate. They find that "the sacrifice time"--the time that elapses until consumption surpasses the value it would have had under the initial saving rate--is roughly six years and is insensitive to the percentage increase in the saving rate ([Delta sub s]). The percentage gain in output at the end of decade--" the decade gain"--is roughly 26% of [Delta sub s], while the percentage gain in consumption is roughly 8% of [Delta sub s]. The "saving rate return"--the internal rate of return on a permanent increase in the saving rate--is roughly 16% and is insensitive to [Delta sub s].