Is a flat tax reform feasible in a grown-up democracy of Western Europe? A simulation study for Germany

  • Fuest C
  • Peichl A
  • Schaefer T
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Abstract

The success of the flat rate income tax in eastern Europe suggests that this concept could also be a model for countries of western Europe. The present paper uses a simulation model to analyze the effects of revenue neutral flat rate tax reforms on equity and efficiency for the case of Germany. We find that a flat rate tax with a low tax rate and a low basic allowance yields positive static welfare effects amounting to approximately 1.8% of income tax revenue but increases income inequality. The increase in income inequality can be avoided by combining a higher tax rate with a higher basic allowance. But in this case, the efficiency gains vanish. We conclude that due to their limited efficiency effects and their problematic distributional impact, flat tax reforms are unlikely to spill over to the grown-up democracies of western Europe.

Author-supplied keywords

  • Distribution
  • Efficiency
  • Equity
  • Flat Tax reform
  • Welfare

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