Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework

Moore, Rachel and Pecoraro, Brandon (2018): Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework.

Abstract

Fiscal policy analysis in heterogeneous-agent models typically involves the use of smooth tax functions to approximate present tax law and proposed reforms. We argue that the tax detail omitted under this conventional approach has macroeconomic implications relevant for policy analysis. In this paper, we develop an alternative approach by embedding an internal tax calculator into a large-scale overlapping generations model that explicitly models key provisions in the Internal Revenue Code applied to labor income. While both approaches generate similar policy-induced patterns of economic activity, we find that the similarities mask differences in key economic aggregates and welfare due to variation in the underlying distribution of household labor supply responses. Absent sufficient tax detail, analysis of specific policy changes - particularly those involving large, discrete effects on a relatively small group of households - using heterogeneous-agent models can be unreliable.

• Item Type: MPRA Paper
• Language: English
• Keywords: dynamic scoring, tax policy, tax functions and calculators, heterogeneous agents
• Subjects: C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C63 - Computational Techniques ; Simulation Modeling; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E62 - Fiscal Policy; H - Public Economics > H3 - Fiscal Policies and Behavior of Economic Agents > H30 - General

References

Adda, J., C. Dustmann, and K. Stevens (2017). The career costs of children. Journal of Political Economy 125 (2), 293-337.

Akhand, H. A. (1996). Effective federal individual income tax function: A specification search. Economics Letters 51, 19-25.

Altig, D. and C. T. Carlstrom (1999). Marginal tax rates and income inequality in a life-cycle model. American Economic Review 89 (5), 1197-1215.

Andreoni, J. (1989). Giving with impure altruism: Applications to charity and ricardian equivalance. The Journal of Political Economy 97 (6), 1447-1458.

Barro, R. J. and C. Sahasakul (1983). Measuring the average marginal tax rate from the individual income tax. The Journal of Business 56 (4), 419-452.

Bénabou, R. (2002). Tax and education policy in a heterogeneous-agent economy: What levels of redistribution maximize growth and efficiency. Econometrica 70 (2), 481-517.

Bridgman, B. (2016, February). Accounting for household production in the national accounts: An update, 1965-2014. Survey of Current Business 95 (5), 1-9.

Chang, Y., S.-B. Kim, K. Kown, and R. Rogerson (2011). Interpreting labor supply regressions in a model of full- and part-time work. American Economic Review 101 (3), 476-481.

Chetty, R., J. N. Friedman, and E. Saez (2013). Using differences in knowledge across neighborhoods to uncover the impacts of the eitc on earnings. The American Economic Review 103 (7), 2683-2721.

Cho, S.-W. and J. L. Francis (2011). Tax treatment of owner occupied housing and wealth inequality. Journal of Macroeconomics 33, 42-60.

Cogan, J. F. (1981). Fixed costs and labor supply. Econometrica 49 (4).

Cooley, T. F. and E. Prescott (1995). Economic growth and business cycles. In T. F. Cooley (Ed.), Frontiers of Business Cycle Research, Chapter 1. Princeton University Press.

DeBacker, J., R. W. Evans, and K. L. Phillips (2017). Integrating microsimulation tax functions into a dge macroeconomic model: A canonical example. Working Paper.

Easterly, W. and S. Rebelo (1993). Marginal income tax rates and economic growth in developing countries. European Economic Review 37, 409-417.

Eika, L., M. Mogstad, and B. Zafar (2014). Educational assortive mating and household income inequality. Federal Reserve Bank of New York Staff Reports (682).

Eissa, N. and J. B. Liebman (1996). Labor supply response to the earned income tax credit. Quarterly Journal of Economics 111 (2), 605-637.

Fernánez-Villaverde, J. and D. Krueger (2010). Consumption and saving over the life cycle: How important are consumer durables? Macroeconomic Dynamics 15.

Fiorito, R. and G. Zanella (2012). The anatomy of the aggregate labor supply elasticity. Review of Economic Dynamics 15, 171-187.

French, E., M. De Nardi, J. Jones, O. Baker, and P. Doctor (2006). Right before the end: asset decumulation at the end of life. Economic Perspectives (Q III), 2-13.

Fullerton, D. and D. L. Rogers (1993). Who Bears the Lifetime Tax Burden? The Brookings Institution.

Gelber, A. M. and J. W. Mitchell (2012). Taxes and time allocation: Evidence from single women and men. The Review of Economic Studies 79 (3), 863-897.

Gervais, M. (2002). Housing taxation and capital accumulation. Journal of Monetary Economics 49, 1461-1489.

Gouveia, M. and R. P. Struass (1994). Effective federal income tax functions: An exploratory empirical analysis. National Tax Journal 47 (2), 317-39.

Gravelle, J. G. and D. J. Marples (2015). The effect of base-broadening measures on labor supply and investment: Considerations for tax reform. Congressional Research Service.

Greenwood, J., N. Guner, G. Kocharkov, and C. Santos (2014). Marry your like: Assortivemating and income inequality (revised version). American Economic Review: Papers & Proceedings 104 (5), 348-353.

Greenwood, J., N. Guner, G. Kocharkov, and C. Santos (2016). Technology and the changing family: A unifed model of marriage, divorce, educational attainment and married female labor-force participation. American Economic Journal: Macroeconomics 8 (1), 1-41.

Gruber, J. W. and R. F. Martin (2003). Does housing wealth make us less equal? the role of durable goods in the distribution of wealth. Federal Reserve Board Working Paper.

Guner, N., R. Kaygusuz, and G. Ventura (2011). Taxation and household labour supply. The Review of Economic Studies 79 (3), 1113-1149.

Heathcote, J., K. Storesletten, and G. L. Violante (2017). Optimal tax progressivity: An analytical framework. Quarterly Journal of Economics 132 (4), 1693-1754.

Holter, H. A., D. Krueger, and S. Stepanchuk (2017). How does tax progessivity and household heterogeneity affect laffr curves? Working Paper.

Hugget, M., G. Ventura, and A. Yaron (2011). Sources of lifetime inequality. The American Economic Review 101, 2923-2954.

IRS (2014). Internal revenue service: Compliance estimates for the earned income tax credit claimed on 2006-2008 returns. Research, Analysis & Statistics Report. Publication 5162.

JCT (2011). Joint committee on taxation: Summary of economic models and estimating practices of the staff of the joint committee on taxation. JCX-46-11

JCT (2015). Joint committee on taxation: Estimating changes in the federal individual income tax: Description of the individual tax model. JCX-75-15

JCT (2018). Joint committee on taxation: List of expiring federal tax provisions 2016-2027. JCX-1-18

Keane, M. and R. Rogerson (2012). Micro and macro labor supply elasticities: A reassessment of conventional wisdom. Journal of Economic Literature 50 (2), 464-476. Keane, M. P. and N. Wasi (2016). Labour supply: The roles of human capital and the extensive margin. The Economic Journal 126, 578-617.

King, R. G., C. I. Plosser, and S. T. Rebelo (2002). Production growth and business cycles: Technical appendix. Computational Economics 20, 87-116.

Krueger, A. B. and A. I. Mueller (2012, May). Time Use, Emotional Well-Being, and Unemployment: Evidence from Longitudinal Data. American Economic Review: Papers & Proceedings 102 (3), 594-599.

Kuhn, P. and F. Lozano (2008, April). The Expanding Workweek? Understanding Trends in Long Work Hours among U.S. Men, 1979-2006. Journal of Labor Economics 26 (2), 311-343.

Kydland, F. E. (1995). Business cycles and aggregate labor market fluctuations. In T. F. Cooley (Ed.), Frontiers of Business Cycle Research, Chapter 1. Princeton University Press.

Ledbetter, M. (2007). Comparison of bea estimates of personal income and irs estimates of adjusted gross income. Bureau of Economic Analysis: Survey of Current Business.

Li, W., H. Liu, F. Yang, and R. Yao (2016). Housing over time and over the life cycle: A structural estimation. International Economic Review 57 (4), 1237-1260.

Li, W. and P.-D. Sarte (2004). Progressive taxation and long-run growth. American Economic Review 95 (5), 1705-1716.

Nichols, A. and J. Rothstein (2016). The earned income tax credit. In R. A. Moffitt (Ed.), Economics of Means-Tested Transfer Programs in the United States, Chapter 2. The University of Chicago Books.

Pence, K. M. (2006). The role of wealth transformations: An application to estimating the effect of tax incentives on saving. Contributions to Economic Analysis and Policy 5 (1).

Plueger, D. (2009). Earned income tax credit participation rate for tax year 2005. Internal Revenue Service Research Bulletin.

Rogerson, R. and J. Wallenius (2009). Micro and macro elasticities in a life cycle model with taxes. Journal of Economic Theory 144, 2277-2292.

Rogerson, R. and J. Wallenius (2013, June). Nonconvexities, Retirement, and the Elasticity of Labor Supply. American Economic Review 103 (4), 1445-1462.

Rupert, P. and G. Zanella (2015). Revisiting wage, earnings, and hours profiles. Journal of Monetary Economics 72, 114-130.

Ventura, G. (1999). Flat tax reform: A quantitative exploration. Journal of Economic Dynamics & Control 23, 1425-1458.

Wang, K. (2016). Bequests in the US: Patterns, Motives and Tax Policy. Ph.D. thesis, Texas AM University.