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

58 Pages Posted: 22 Jun 2018 Last revised: 16 Sep 2018

See all articles by Rachel Moore

Rachel Moore

Government of the United States of America - Joint Committee on Taxation

Brandon Pecoraro

Government of the United States of America - Joint Committee on Taxation

Date Written: September 6, 2018

Abstract

Fiscal policy analysis in heterogeneous-agent models typically involves the use of smooth tax functions to approximate complex present tax law and proposed reforms. In this paper, we explore the extent to which the tax detail omitted under this conventional approach has macroeconomic implications relevant for policy analysis. To do this, we develop an alternative approach by embedding an internal tax calculator into a large-scale overlapping generations model that, while conditioning on idiosyncratic household characteristics, explicitly models key provisions in the Internal Revenue Code applied to labor income. We find that for a comparative-static steady state analysis of a given tax policy change, both approaches generate similar policy-induced patterns of macroeconomic activity despite variation in the underlying patterns of household tax-preferred consumption and labor supply behavior. However, this variation in underlying behavior is associated with significant quantitative and qualitative differences in macroeconomic aggregates along the transition path immediately following a policy change. Consequentially, although the use of unconditional smooth tax functions may be a reasonable modeling simplification for steady state analysis of tax policy, caution should be taken for their use in transition path analysis within heterogeneous-agent models.

Keywords: dynamic scoring, tax policy, tax functions and calculators, heterogeneous agents

JEL Classification: C63, E62, H30

Suggested Citation

Moore, Rachel and Pecoraro, Brandon, Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework (September 6, 2018). Available at SSRN: https://ssrn.com/abstract=3193142 or http://dx.doi.org/10.2139/ssrn.3193142

Rachel Moore

Government of the United States of America - Joint Committee on Taxation

Room 1625 Longworth House Office Building
Washington, DC 20515
United States

Brandon Pecoraro (Contact Author)

Government of the United States of America - Joint Committee on Taxation ( email )

Room 1625 Longworth House Office Building
Washington, DC 20515
United States

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