Does a Simpler Income Tax Yield More Equity and Efficiency? Clemens Fuest, Andreas Peichl and Thilo Schaefer* Abstract This article investigates the impact of tax simplification on various indicators of the efficiency of the tax system and on the distribution of income. The analysis is based on a simulation model (FiFoSiM) using German income tax and household survey microdata. We model tax simplification as the abolition of a set of deductions from the income tax base. We find that this form of tax base simplification leads to a reduction in the use of professional tax advice, a more equitable income distribution and an increase in tax revenue. If this is combined with a reduction of income tax rates to preserve revenue neutrality, the effects depend on the type of rate schedule adjustment. The combination with a flat rate tax increases income inequality at the expense of the middle class, but it also leads to efficiency gains because tax distortions of labour supply are reduced. The combination with a rate schedule adjustment, which preserves the directly progressive schedule reduces inequality but increases overall tax distortions. We conclude that the effects of tax base simplification on after tax income inequality and tax distortions mainly depend on the type of tax schedule adjustment. (JEL Codes: D3, H2, J22) Keywords: Flat tax, income tax reform, tax simplification. 1 Introduction The simplification of the tax system is a key objective of many income tax reform proposals in various countries. 1 This is not only because complexity leads to high compliance costs for taxpayers and tax evasion. The complexity of the income tax system is also widely seen as an obstacle to fairness and efficiency beyond costs of administration and compliance. For instance, complexity is thought to be a barrier for achieving a fair distribution of the tax burden because it might allow taxpayers with high incomes to use tax loopholes and reduce their tax burden. Therefore, * Center for Public Economics, University of Cologne, Albertus-Magnus-Platz, 50923 Cologne, Germany, e-mails: clemens.fuest@.uni-koeln.de; a.peichl@uni-koeln.de; schaefer@fifo-koeln.de, respectively. Center for Public Economics, University of Cologne, Zuelpicher Str. 182, 50937 Cologne, Germany. The authors would like to thank two anonymous referees, Christian Bergs, Frank Brenneisen, Rene´ Frey, Guyonne Kalb, Panayiota Lyssiotou and Axel Schmidt for their helpful contributions. The usual disclaimer applies. 1 Cf. Gale (2001) for the US, James, Sawyer and Wallschutzky (1997) for Australia, New Zealand and the United Kingdom, Tran-Nam (2000) for Australia or Fuest, Peichl and Schaefer (2007a) and Wagner (2006) for Germany. ß The Author 2008. Published by Oxford University Press on behalf of Ifo Institute for Economic Research, Munich. All rights reserved. For permissions, please e-mail: journals.permissions@oxfordjournals.org 73 CESifo Economic Studies, Vol. 54, 1/2008, 73–97 doi:10.1093/cesifo/ifn003 Advance Access publication 20 February 2008