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Macroeconomic implications of modeling the Internal Revenue Code in a heterogeneous-agent framework

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  • Moore, Rachel
  • Pecoraro, Brandon

Abstract

Tax 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 debt-constant 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 a debt-financed 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.

Suggested Citation

  • Moore, Rachel & Pecoraro, Brandon, 2020. "Macroeconomic implications of modeling the Internal Revenue Code in a heterogeneous-agent framework," Economic Modelling, Elsevier, vol. 87(C), pages 72-91.
  • Handle: RePEc:eee:ecmode:v:87:y:2020:i:c:p:72-91
    DOI: 10.1016/j.econmod.2019.07.007
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    1. Macroeconomic Implications of Modeling the Internal Revenue Code in a Heterogeneous-Agent Framework
      by Christian Zimmermann in NEP-DGE blog on 2018-10-10 14:52:57

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    Cited by:

    1. Martino Tasso, 2020. "Do details matter? An analysis of Italian personal income tax," Temi di discussione (Economic working papers) 1301, Bank of Italy, Economic Research and International Relations Area.
    2. Moore, Rachel & Pecoraro, Brandon, 2019. "Modeling the Internal Revenue Code in a heterogeneous-agent framework: An application to TCJA," MPRA Paper 93110, University Library of Munich, Germany.
    3. Rachel Moore & Brandon Pecoraro, 2020. "Dynamic Scoring: An Assessment of Fiscal Closing Assumptions," Public Finance Review, , vol. 48(3), pages 340-353, May.

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    More about this item

    Keywords

    Dynamic scoring; Tax functions and calculators; Heterogeneous agents;
    All these keywords.

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E62 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Fiscal Policy
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General

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