Evaluating the Impact of a Tax Reform in Portugal

Abstract

This dissertation aims to propose a restructuring of the Portuguese Tax System to increase household welfare, while maintaining a balanced budget. A modified Auerbach-Kotlikoff (1987) overlapping generations model, adapted to the Portuguese context with heterogeneity in age and education, is employed in three experiments. The first experiment applies parameters from the Danish Tax System, the second uses OECD average values, and the third follows the literature recommendations, which involve an increase in the consumption tax rate alongside reductions in the individual income tax rate and employee social security contributions. The third experiment employed a trial-and-error approach to identify the effective consumption tax rate, effective individual income tax rate, and social security contributions that would increase household utility. Specifically, it included a 0.5 percentage point increase in the effective consumption tax rate, a reduction in employee social security contributions from 11% to 5%, and a decrease in the effective individual income tax rate from 12.87% to 5%. The analysis focuses on the long-term impacts of the different experiments. The results indicate that the third experiment offers the greatest improvement in utility, particularly among those with higher levels of education. Furthermore, increases in long-run steady-state values of consumption, labour supply, and capital stock are observed. Although the overall utility gains are relatively modest, the study employs a long-term perspective. Hence, the aim is to provide guidance for future policy decisions.