A proposed tax reform for China: Enhancing consumption and pension sustainability

Abstract

This study examines the long-run effects of a proposed tax reform in China that shifts the burden from income taxes to consumption taxes, addressing the dual challenges of an aging population and low household consumption. Using a heterogeneous-agent overlapping generations (OLG) model with earnings and health risks, we evaluate the tax reform that reallocates fiscal burdens while accounting for marital status and gender. Our findings show that demographic aging significantly raises income and payroll tax pressures, reducing consumption and welfare. In contrast, consumption tax-based reform enhances capital accumulation, sustains pensions without raising payroll taxes, and improves welfare. The results show the value of consumption taxation in promoting fiscal sustainability and efficiency in aging societies.