Simulating alternative tax reform proposals with a computable general equilibrium (CGE) model

This paper reports the results of simulations of a dynamic computable general equilibrium model of the U.S. economy for alternative proposed federal tax law changes. This model contains 27 private sectors, 8 household income groups, 2 factors (labor and capital), investment, rest of the worlds, as well as disaggregation of government into a number of spending and revenue categories for all three levels of government (federal, state and local). The model has been calibrated with the most recent data available, typically fiscal year 2013.

The simulations will examine spending changes necessitated by the assumed tax policies for their effects on infrastructure, transfer payments and on economic activity. Changes in tax rates have measurable effects on economic activities, which can be quantified using this national dynamic model. Among the changes that will be examined is the replacement of the existing federal tax system with a flat tax, a retail sales tax or a value added tax.  The authors will also report on certain proposed changes in the corporate income tax and in the top brackets of the personal income tax.

Economic indicators to be reported on include U.S. GDP, public and private employment, investment and federal, state and local tax revenues on a 25 year horizon. Additionally, the output will include distributional effects of policy changes on households of different income groups, including effects on income, savings and use of transfer programs. The expected results of replacing the current federal tax system with a flat tax will show that in the time horizon of the model, negative short term effects such as lower consumption will be replaced with beneficial effects resulting in households making decisions regarding work and savings, resulting in positive effects to their lifetime ‘utility’.