The Tax Policy Center Microsimulation Model
The Urban-Brookings Tax Policy Center's large-scale microsimulation model produces revenue and distribution estimates of the U.S. federal tax system. The model is similar to those used by the Congressional Budget Office (CBO), the Joint Committee on Taxation (JCT), and the Treasury's Office of Tax Analysis (OTA).
The model is based on data from the 2004 public-use file (PUF) produced by the Statistics of Income (SOI) Division of the Internal Revenue Service (IRS). The PUF contains 150,047 records with detailed information from federal individual income tax returns filed in the 2004 calendar year. We attach additional information on demographics and sources of income that are not reported on tax returns through a constrained statistical match of the public-use file with the March 2005 Current Population Survey (CPS) of the U.S. Census Bureau. That match also generates a sample of individuals who do not file income tax returns (“non-filers”). The dataset combining filers from the PUF (augmented by demographic and other information from the CPS) and non-filers from the CPS allows us to carry out distribution analysis on the entire population rather than just the segment that files individual income tax returns and to model tax proposals that would potentially affect current non-filers.
The tax model consists of two components: a statistical routine that "ages" or extrapolates the 2004 data to create a representative sample of both filing and non-filing tax units for future years1; and detailed tax calculators that: (a) compute individual income tax liability for all filers in the sample under current law and under alternative policy proposals; (b) compute the employee and employer shares of payroll taxes for Social Security and Medicare; (c) assign the burden of the corporate income tax to tax units; and (d) determine the expected value of estate tax liability for each tax unit in the sample using an estate tax calculator in combination with age-specific mortality rates.
Aging and Extrapolation Process
For the years from 2005 to 2022, we "age" the data based on CBO forecasts and projections for growth in various types of income, CBO and JCT baseline revenue projections, IRS estimates of future growth in the number of tax returns, JCT estimates of the distribution of tax units by income, and Bureau of the Census data on the size and age-composition of the population. We use actual 2005 through 2009 data when they are available.2 A two-step process produces a representative sample of the filing and non-filing population in years beyond 2004. We first inflate the dollar amounts for income, adjustments, deductions, and credits on each record by their appropriate forecasted per capita growth rates. We use the CBO’s forecast for per capita growth in major income sources such as wages, capital gains, and non-wage income (interest, dividends, Social Security benefits, and others). We assume that most other items grow at CBO’s projected growth rate for per capita personal income. In the second stage of the extrapolation, we use a linear programming algorithm to adjust the weights on each record so that the major income items, adjustments, and deductions match aggregate targets. We also attempt to adjust the overall distribution of income to match published information from the Statistics of Income (SOI) division of the Internal Revenue Service (IRS) for 2004 through 2009 and published estimates of the 2010 and 2011 distributions from JCT. We extrapolate recent trends to obtain projected distributions for years beyond 2011.
Individual Income Tax Calculator
Based on the extrapolated data set, we can simulate policy options using a detailed tax calculator that captures most features of the federal individual income tax system, including the alternative minimum tax (AMT). The model reflects major income tax legislation enacted through the end of 2011, including the tax compromise legislation signed into law in December of 2010 that temporarily extended provisions in the 2001 and 2003 tax acts, EGTRRA and JGTRRA.3 We model nine major provisions of those acts: 1) changes in marginal tax rates; 2) the new 10 percent tax bracket; 3) credits for children and dependent care; 4) itemized deduction limitations; 5) personal exemption phase outs; 6) exemption levels and preferences under the AMT; 7) education incentives; 8) retirement and pension measures; and 9) the marriage penalty provisions, which increased the standard deduction, 15 percent bracket, and earned income tax credit for married couples. We also model JGTRRA’s changes to the taxation of qualified dividends and capital gains.
In our distribution tables, we assume that the burden of the individual income tax falls on the payer. CBO, JCT, and Treasury use the same assumption.
Payroll Tax Calculator
Using the extrapolated dataset we also calculate federal payroll taxes for Social Security and Medicare. One complication is that for married couples, our tax return data only provide information on combined earnings. Payroll taxes are based on individual earnings; this is important because the amount of earnings subject to the Social Security portion of payroll taxes is capped at about $100,000 (indexed annually). For married couples, we therefore rely on the split in wages observed on the CPS record to which the PUF record is matched in order to assign individual earnings.
In our distribution tables, we assume that the worker bears the burden of both the employer and employee portions of payroll taxes. This premise is widely accepted among economists. CBO, JCT, and Treasury make the same assumption for their distribution tables.
Assigning Corporate Tax Burden to Individuals
Although firms pay the corporate income tax, the economic incidence of the tax falls on individuals. TPC’s tax model therefore distributes the burden of the tax to individuals. The incidence of the corporate tax, however, is an unsettled theoretical issue. The tax could be passed on to labor in the form of lower real wages, or to the owners of some or all capital in the form of lower real rates of return.
In September 2012, we updated the assumptions we use to distribute the corporate income tax; we estimate that 60 percent is borne by shareholders, 20 percent by all capital owners, and 20 percent by labor.4 Previously, we assumed that the entire burden fell on owners of capital. Our current assumptions are similar to those now made by CBO and Treasury. The JCT does not distribute the corporate tax.
We rely on CBO for our projections of baseline corporate tax liability and, when available, on JCT estimates of changes in corporate tax liability due to tax proposals.
Because the income tax data in our model contain no direct information about wealth holdings, we rely on information from the Survey of Consumer Finances (SCF) to develop imputations of assets and liabilities. Specifically, we impute asset items and liabilities to each record in the income-tax file based on regressions of those wealth components against explanatory variables that exist on both the SCF and SOI datasets. To mitigate the problem of the SCF’s small sample size —it contains fewer than 5,000 observations—we pool data from the 2001 and 2004 surveys. In addition to roughly doubling the sample size, combining data from the two years smoothes out some of the temporal variation in asset values. We then calibrate the imputed number of individuals owning each type of asset (and liability) and their aggregate values to match SCF totals, augmented by the net worth of the Forbes 400.5 We further adjust the imputed distribution of each asset and liability by income class to more closely resemble those reported in the SCF.
We assign values for most estate tax deductions and credits based on averages calculated from SOI estate tax data. Our estate tax calculator then determines estate tax liability for each record in the database, based on the values for gross estate, deductions, and credits and the relevant estate tax rates and brackets. Finally we calculate each record's expected value of gross estate and net estate tax liability by multiplying by age-specific mortality rates. We employ a linear programming algorithm to reweight the records to ensure that our baseline estimates of the distribution and aggregate values for gross estate and its components match the most recent published estate tax data from SOI.6
In our distribution tables, we assume the burden of the estate tax is borne by decedents, the same assumption used in the past by Treasury. Neither CBO nor JCT includes the estate tax in their incidence analysis.
In recent years, TPC has updated the tax model's estate tax module to incorporate the latest data on estate tax filers from the Statistics of Income Division of the IRS and the retirement savings module to be consistent with 2004 data. We also expanded the retirement module to allow us to model the revenue and distributional implications of implementing automatic enrollment in IRAs and 401(k) retirement plans. This latest version of the tax model also includes refined imputations of itemized deductions, such as charitable contributions and home mortgage interest, for “non-itemizers” —people who claim only the standard deduction on their tax return. These imputations allow us to model the distribution and revenue implications of proposals to replace certain credits with deductions.
The latest version of our microsimulation model also includes a completely overhauled and expanded education module. We use data from the October 2003 and October 2004 CPS, as well as the National Postsecondary Student Aid Study (NPSAS) to impute student status, characteristics, and education expenditures onto the tax model database. This allows us to model current tax incentives for education—such as the HOPE and Lifetime Learning Credits and the deduction for higher education expenses—as well as to examine the revenue and distributional implications of combining or modifying these tax programs. We can also model current spending programs such as Pell Grants, and examine the revenue and distributional effects of changes to the Pell Grant rules.
We have also made several improvements that allow us to model a variety of indirect taxes, including excise taxes, broad-based consumption taxes (e.g. a value-added tax or VAT), and environmental taxes. Using data from the Consumer Expenditure Survey (CEX), the Medical Expenditure Panel Survey (MEPS), and the American Housing Survey (AHS), we produce detailed estimates of the consumption expenditures of individuals in the tax model database. We also use the Urban Institute’s DYNASIM model to estimate the amount of future consumption financed out of current wealth, which allows us to analyze transitional issues for options that move the tax system from an income base to a consumption base. This work gives the TPC the ability to estimate the distributional impact of hybrid income-consumption tax systems and other comprehensive reform options, such as the plans endorsed by the President’s Advisory Panel for Federal Tax Reform in 2005 and, more recently, by the Bipartisan Policy Center’s Debt Reduction Task Force.
Finally, using data from the Medical Expenditure Panel Survey (MEPS), we collaborated with the Urban Institute’s Health Policy Center to impute details of health insurance eligibility, coverage, and medical expenses in the tax model database. With a modification to the tax calculator, the imputed information allows us to analyze policies that change the tax treatment of health insurance, such as repealing or limiting the currently unlimited exclusion of employer-provided health insurance. We have revised the health module to account for provisions in the Patient Protection and Affordable Care Act and modifications in subsequent legislation such as the Medicare and Medicaid Extenders Act of 2010.
Last Updated: September 19, 2012
1 A tax unit is an individual, or a married couple who file a tax return jointly, along with all dependents of that individual or married couple. A tax unit is therefore different than a family or a household in certain situations. For example, two persons cohabiting would be considered one household but if they were not legally married, they would file separate tax returns and thus be considered two tax units.
2 In our latest update, we also used the available preliminary data for the 2010 tax year.
3 EGTRRA is the Economic Growth and Tax Relief Reconciliation Act of 2001; JGTRRA is the Jobs and Growth Tax Relief Reconciliation Act of 2003.
4 See Nunns (2012). "How TPC Distributes the Corporate Income Tax." Based on our review of research on the issue, we do not assign any of the burden to consumers.
5 The SCF specifically omits data on the Forbes 400. We need to add them to the file to account for the substantial share of assets that they own.
6 For a detailed description of TPC's estate tax methodology, see Burman, Lim, and Rohaly (2008). "Back from the Grave: Revenue and Distributional Effects of Reforming the Federal Estate Tax."