How the Tax Policy Center Uses Microsimulation Models Len Burman Urban-Brookings Tax Policy Center and Syracuse University For presentation at Microsimulation Modelling for Fiscal Policy Analysis Seville, September 23, 2016 www.taxpolicycenter.org Background on TPC Tax Policy Center Founded in 2002 Nonpartisan venture of two respected nonprofit research organizations: The Urban Institute and the Brookings Institution Most of our funding comes from foundations. We make our research and policy analysis available to the public in clear accessible terms Our goal is to improve the quality of tax policy discourse in the US www.taxpolicycenter.org 1 The TPC microsimulation tax model We have the same kinds of modeling tools used by government agencies such as CBO, Treasury, and JCT Many staff have experience working in government agencies www.taxpolicycenter.org 2 TPC tax model Individual income tax calculator – Based on weighted sample of 145,858 tax returns filed in 2006 (Public Use File or PUF) – Inflate/reweight to hit 100 targets for 2011 – Age and extrapolate based on CBO baseline and distributional targets Add demographic information, nonfilers from CPS Impute wealth, education, consumption, health, retirement www.taxpolicycenter.org 3 Other taxes modeled Payroll taxes Assigning corporate tax burden Estate tax Excise taxes VAT www.taxpolicycenter.org 4 Uses of model Revenue estimating Distribution Effective marginal tax rates See: http://www.taxpolicycenter.org/resources/brief-description-tax-model www.taxpolicycenter.org 5 The tax system does more than raise revenue 200 tax expenditures = $1.4 trillion in 2015 Policymakers have lots of new ideas Modeling them is often a challenge www.taxpolicycenter.org 6 index of tax expenditure supply: requests to JCT 16,000 14,000 12,000 10,000 8,000 6,000 4,000 2,000 0 1987-88 1989-90 1991-92 1993-94 1995-96 1997-98 1999-00 2001-02 2003-04 2005-06 2007-08 2009-10 Source: Joint Committee on Taxation. Includes “a small number of requests for data other than revenue requests.” www.taxpolicycenter.org 7 Index of quantity and complexity of tax proposals: length of Administration tax proposal descriptions www.taxpolicycenter.org 8 Illustration of challenges of tax modeling Jeb Bush’s Reform and Growth Act of 2017 www.taxpolicycenter.org 9 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision How to projectChange data forward? Repeal AMT -361 Cut individual income tax rates (max 28%) -2,742 Cut capital income taxes (max rate 20%) -316 Repeal AGI phaseouts (Pease and PEP) -305 Increase standard deduction -815 Increase EITC for childless workers -48 Trim tax expenditures 1,467 Marriage penalty relief -527 Social Security tax relief for workers 67 and older -259 Business tax changes -350 Total -4,257 www.taxpolicycenter.org 10 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision Change Repeal AMT -361 Cut individual income tax rates (max 28%) Easy -2,742 Cut capital income taxes (max rate 20%) -316 if no behavioral Repeal AGI phaseouts (Pease and PEP) -305 response Increase standard deduction -815 Increase EITC for childless workers -48 Trim tax expenditures 1,467 Marriage penalty relief -527 Social Security tax relief for workers 67 and older -259 Business tax changes -350 Total -4,257 www.taxpolicycenter.org 11 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision Change Repeal AMT -361 Cut individual income tax rates (max 28%) -2,742 Cut capital income taxes (max rate 20%) -316 Repeal AGI phaseouts (Pease and PEP) Model behavioral -305 Increase standard deduction response—short- and -815 long-term Increase EITC for childless workers -48 Trim tax expenditures 1,467 Marriage penalty relief -527 Social Security tax relief for workers 67 and older -259 Business tax changes -350 Total -4,257 www.taxpolicycenter.org 12 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision Change Repeal AMT -361 Cut individual income tax rates (max 28%) -2,742 Cut capital income taxes (max rate 20%) -316 Repeal AGI phaseouts (Pease and PEP) -305 Increase standard deductionStraightforward to model the sometimes -815 complex decisions for individuals Increase EITC for childless workers -48 Trim tax expenditures 1,467 Marriage penalty relief -527 Social Security tax relief for workers 67 and older -259 Business tax changes But behavioral response to complex incentives is -350 uncertain Total -4,257 www.taxpolicycenter.org 13 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision Change Repeal AMT -361 Cut individual income tax rates (max 28%) -2,742 Cut capital income taxes (max rate 20%) -316 Repeal AGI phaseouts (Pease and PEP) -305 Increase standard deduction -815 Increase EITC for childless workers -48 Trim tax expenditures Head and spouse earnings not broken 1,467 out on PUF (impute from CPS) Marriage penalty relief -527 Social Security tax relief for workers 67 and older -259 Business tax changes -350 Total -4,257 www.taxpolicycenter.org 14 Revenue Effect of Bush Individual Income and Payroll Tax Proposals, 2016-2026, in $Billions Revenue Provision Change Repeal AMT -361 Cut individual income tax rates (max 28%) -2,742 Cut capital income taxes (max rate 20%) -316 Repeal AGI phaseouts (Pease and PEP) -305 Increase standard deduction -815 Increase EITC for childless workers -48 Trim tax expenditures Age not on PUF (Assign based on IRS 1,467 Marriage penalty relief tabs) -527 Social Security tax relief for workers 67 and older -259 Business tax changes -350 Total -4,257 www.taxpolicycenter.org 15 Special challenges in modeling corporate income taxes No PUF Corporations can be very complex - Many lines of business, spread across many different taxing jurisdictions Tax info reported to regulators often differs from actual tax liability We are planning to build a corporate tax model based on COMPUSTAT data and detailed industry tabulations produced by IRS www.taxpolicycenter.org 16 Revenue Effect of Bush Corporate and Estate Tax Proposals, 2016-2026, in $Billions Revenue Provision Change 20% corporate rate, repeal AMT -1,653 Expensing plus repeal interest deduction -813 Territorial system These provisions would be -159 8.75% tax on foreign accrued profits relatively easy to model 129 with a corporate tax model Trim corporate tax expenditures 245 (Although accurately Permanent R&E credit -81 modeling behavioral Total for corporate income tax response still a challenge.) -2,331 Repeal estate tax + carryover basis -185 www.taxpolicycenter.org 17 Revenue Effect of Bush Corporate and Estate Tax Proposals, 2016-2026, in $Billions Revenue Provision Change 20% corporate rate, repeal AMT -1,653 Expensing plus repeal interest deduction -813 Territorial system Deferred income of -159 multinationals very hard to 8.75% tax on foreign accrued profits model, even with good data 129 Trim corporate tax expenditures 245 Behavioral responses even Permanent R&E credit harder -81 Total for corporate income tax -2,331 Repeal estate tax + carryover basis -185 www.taxpolicycenter.org 18 Revenue Effect of Bush Corporate and Estate Tax Proposals, 2016-2026, in $Billions Revenue Provision Change 20% corporate rate, repeal AMT. -1,653 Expensing plus repeal interest deduction -813 Territorial system -159 8.75% tax on foreign accrued profits 129 Trim corporate tax expenditures 245 No public estate tax return Permanent R&E credit data, but can approximate -81 by killing off people Total for corporate income tax probabilistically in -2,331 Repeal estate tax + carryover basis PUF. -185 Info on carryover basis for one year on 8939 (not public) and SCF. www.taxpolicycenter.org 19 The changing form of large U.S. businesses www.taxpolicycenter.org Source: Cooper, et. al (2015) 20 Pass-throughs are very complex Source: Cooper, et. al (2015) www.taxpolicycenter.org 21 Change in After-Tax Income Under Bush Proposal By expanded cash income percentile, 2017 How to measure 14% income? 12% 10% 8% 6% 4% 2% 0% Lowest Second Middle Fourth 80–90 90–95 95–99 Top 1 Top 0.1 quintile quintile quintile quintile percent percent Source: Urban-Brookings Tax Policy Center Microsimulation Model (version 0515-3). www.taxpolicycenter.org 22 Measuring economic status Income reported on tax returns is incomplete - Missing income excluded from tax (e.g., fringe benefits) - Missing most transfers (e.g., public assistance) - Capital gains reported on “realization basis” - Business income may overstate or understate actual income - Failure to index capital income and expense www.taxpolicycenter.org 23 Annual income as measure of economic status Income varies over the life cycle Transitory shocks can cause annual income to deviate substantially from “permanent income” Lifetime income would be a better measure, but requires panel data and way to project future income, which depends on factors not reported on tax returns Consumption may be better alternative (permanent income hypothesis), but consumption data very noisy Auerbach, Kotlikoff, Koehler propose alternative method based on SCF data www.taxpolicycenter.org 24 Challenge in measuring economic incidence Corporate income tax Payroll tax Economic development tax incentives (claimed by high-income taxpayers, but aimed at providing benefits for low-income households) Tax-exempt bonds (surprisingly complex incidence) www.taxpolicycenter.org