Integrating Microsimulation Models of Tax Policy into a DGE Macroeconomic Model

Abstract

This paper proposes a method for integrating individual effective tax rates and marginal tax rates computed from a microsimulation (partial equilibrium) model of tax policy with a dynamic general equilibrium (DGE) model of tax policy that can provide macroeconomic analysis or dynamic scores of tax reforms. Our approach captures the rich heterogeneity, realistic demographics, and tax-code detail of the microsimulation model and allows this detail to inform a general equilibrium model with a relatively high degree of heterogeneity. In addition, we propose a functional form in which tax rates depend jointly on the levels of both capital income and labor income.

Keywords: Dynamic General Equilibrium, Tax Policy, Fiscal Policy

JEL Classification: C61, C81, D58, E21, E62, H24, H30