Tax-benefit model

Last updated

A tax-benefit model is a form of microsimulation model. It is usually based on a representative or administrative data set and certain policy rules. These models are used to cost certain policy reforms and to determine the winners and losers of reform. One example is EUROMOD, which models taxes and benefits for 27 EU states, and its post-Brexit offshoot, UKMOD. [1]

Contents

Overview

Tax-benefit models are used by policy makers and researchers to examine the effects of proposed or hypothetical policy changes on income inequality, poverty and government budget. Their primary advantage over conventional cross-country comparison method is that they are very powerful at evaluating policy changes not only ex post, but also ex ante.

Generally, tax-benefit models can simulate income taxes, property taxes, social contributions, social assistance, income benefits and other benefits.

The underlying micro-data are obtained mainly through household surveys. These data include information about households' income, expenditure and family composition.

Most of the tax-benefit models are operated by governments or research institutions. Very few models are publicly available.

Depending on their purpose, tax-benefit models may or may not ignore behavioral responses of individuals.

General framework

The basic steps in conducting research using a simple tax-benefit model are:

  1. Gross micro-data describing households' income, expenditure and family composition are collected and processed;
  2. These data enter a tax-benefit model;
  3. First simulation takes place;
  4. Disposable income of each household is calculated and the results of the simulation are summarized;
  5. A set of rules of the policies enters the model and the second simulation takes place;
  6. Disposable income of each household is calculated and the results of the simulation are summarized;
  7. The impact of the set of policy changes is evaluated by comparing the results from the two simulations.

A dynamic tax-benefit model PoliSim's webpage provides an illustration diagram of the process. Since this model is dynamic, it also requires data on probabilistic characteristics of the underlying population. These data would be created in step 1 and enter the model in step 2.

Taxonomy

Basically, there are two properties that make given tax-benefit models different from each other. A model can be:

  1. Arithmetical or behavioral;
  2. Static or dynamic.

Arithmetical vs. behavioral tax-benefit models

Arithmetical tax-benefit models can be viewed as advanced calculators. They typically show only direct effects of the reform on individuals' disposable income, tax revenue, income inequality and other aspects of interest. These models do not take into account behavioral responses of people such as decreased labor supply induced by a tax hike. This is not problematic when, for example, a researcher is only interested in studying the effects of a marginal change in tax liability on overall inequality.

On the other hand, behavioral tax-benefit models account for behavioral responses of people to policy changes. As opposed to arithmetical models, these models basically simulate two periods:

  1. In the first period, the arithmetical calculation of first-order effects of a reform on individuals' disposable income is performed;
  2. Then, behavioral reactions of people to the reform enter the model, and the second-order effects of the reform are estimated.

Static vs. dynamic tax-benefit models

Static tax-benefit models provide an opportunity to study only "morning after" effects of a policy change. That is, only one period ahead is considered, so only immediate impact of a reform is estimated.

On the other hand, dynamic tax-benefit models aim at simulating the selected aspects of the economy over long periods of time. They utilize data on probabilistic characteristics of the underlying population to account for individuals' aging, changes in marital status, new children, etc. These models are used, for example, to study the long-run effects of a change in tax code related to the number of children in the family.

Summary

The four basic types of tax-benefit models with illustrative examples can be summarized by the table below:

Taxonomy of tax-benefit models with examples
ArithmeticBehavioral
StaticA small change in tax liabilityA significant change in tax liability
DynamicA change in property taxA change in tax code related to the number of children in the family

Dynamic behavioral tax-benefit models are closely related to agent-based models, especially when the model also accounts for interactions between individuals. [2]

Data preparation

Most of tax-benefit models heavily depend on the availability and accuracy of the underlying micro-data. As Holly Sutherland, the director of EUROMOD and one of the most influential researchers in this area, points out, "any model would be as good as the data available to it". [3]

Tax-benefit models assume that the data from surveys represent the population of interest. This assumption is not easy to satisfy. Not only the proportions of different families in the sample might not reflect the true proportions, but also there is a problem of coverage. That is, the census is likely to exclude such groups as armed forces, people in prisons, hospitals or nursing houses, people living abroad. [3]

Some households may (intentionally or unintentionally) report less income than actually was received. Because static tax-benefit models are usually built under hypothesis that individuals report all their incomes, the results of the simulations may be inaccurate. [4]

It is important that the underlying micro-data are up to date, so the surveys should be conducted frequently.

Computing power

Due to their complexity, tax-benefit models (especially behavioral or dynamic ones) usually require extensive computational resources.

Examples

There are many tax-benefit models all over the world. Below are some of the most prominent models:

Selected tax-benefit models
CountryModel(s)
AustraliaAPPSIM, STINMOD+
CanadaDYNACAN
E.U.EUROMOD
Global South (selected African, Asian and Latin American countries) SOUTHMOD
FinlandTUJA
FranceTAXIPP
GermanyIZAΨMOD, MIKMOD-ESt
IrelandSWITCH
LuxembourgLuxTaxBen
SwedenSWEtaxben
U.K.TAXBEN, UKMOD
U.S.PoliSim, TRIM3, TAXSIM

See also

Related Research Articles

<span class="mw-page-title-main">Computer simulation</span> Process of mathematical modelling, performed on a computer

Computer simulation is the process of mathematical modelling, performed on a computer, which is designed to predict the behaviour of, or the outcome of, a real-world or physical system. The reliability of some mathematical models can be determined by comparing their results to the real-world outcomes they aim to predict. Computer simulations have become a useful tool for the mathematical modeling of many natural systems in physics, astrophysics, climatology, chemistry, biology and manufacturing, as well as human systems in economics, psychology, social science, health care and engineering. Simulation of a system is represented as the running of the system's model. It can be used to explore and gain new insights into new technology and to estimate the performance of systems too complex for analytical solutions.

A tax cut represents a decrease in the amount of money taken from taxpayers to go towards government revenue. Tax cuts decrease the revenue of the government and increase the disposable income of taxpayers. Tax cuts usually refer to reductions in the percentage of tax paid on income, goods and services. As they leave consumers with more disposable income, tax cuts are an example of an expansionary fiscal policy. Tax cuts also include reduction in tax in other ways, such as tax credit, deductions and loopholes.

<span class="mw-page-title-main">Income distribution</span> How a countrys total GDP is distributed amongst its population

In economics, income distribution covers how a country's total GDP is distributed amongst its population. Economic theory and economic policy have long seen income and its distribution as a central concern. Unequal distribution of income causes economic inequality which is a concern in almost all countries around the world.

Articles in economics journals are usually classified according to JEL classification codes, which derive from the Journal of Economic Literature. The JEL is published quarterly by the American Economic Association (AEA) and contains survey articles and information on recently published books and dissertations. The AEA maintains EconLit, a searchable data base of citations for articles, books, reviews, dissertations, and working papers classified by JEL codes for the years from 1969. A recent addition to EconLit is indexing of economics journal articles from 1886 to 1968 parallel to the print series Index of Economic Articles.

Pensim2 is a dynamic microsimulation model to simulate the income of pensioners, owned by the British Department for Work and Pensions.

Microsimulation is a category of computerized analytical tools that perform analysis of activities such as highway traffic flowing through an intersection, financial transactions, or pathogens spreading disease through a population on the granularity level of individuals. Synonyms include microanalytic simulation and microscopic simulation. Microsimulation, with its emphasis on stochastic or rule-based structures, should not be confused with the similar complementary technique of multi-agent simulation, which focuses more on the behaviour of individuals.

In economics, personal income refers to the total earnings of an individual from various sources such as wages, investment ventures, and other sources of income. It encompasses all the products and money received by an individual.

Euromod, officially stylised as EUROMOD, is a European Union-wide tax-benefit model originally maintained, developed and managed by the Institute for Social and Economic Research at the University of Essex. Since 2021 Euromod is maintained, developed and managed by the Joint Research Centre of the European Commission, in collaboration with Eurostat and national teams from the EU countries. It belongs to the class of static microsimulation models and has modules for all 27 EU member states.

<span class="mw-page-title-main">Income in the United Kingdom</span>

Median household disposable income in the UK was £29,400 in the financial year ending (FYE) 2019, up 1.4% (£400) compared with growth over recent years; median income grew by an average of 0.7% per year between FYE 2017 and FYE 2019, compared with 2.8% between FYE 2013 and FYE 2017.

The Policy Simulation Model (PSM) is a static microsimulation model which encapsulates the tax and benefits system, and population, of Great Britain. It is based on survey data from the Family Resources Survey (FRS) which is uprated to simulate the current year, together with several years into the future through a process of static uprating. The uprating process covers a complex range of processes, ranging from simple numerical uprating of financial values, to modelling the draw-down of old benefits through to the implications of the rising state pension age.

UrbanSim is an open source urban simulation system designed by Paul Waddell of the University of California, Berkeley and developed with numerous collaborators to support metropolitan land use, transportation, and environmental planning. It has been distributed on the web since 1998, with regular revisions and updates, from www.urbansim.org. Synthicity Inc coordinates the development of UrbanSim and provides professional services to support its application. The development of UrbanSim has been funded by several grants from the National Science Foundation, the U.S. Environmental Protection Agency, the Federal Highway Administration, as well as support from states, metropolitan planning agencies and research councils in Europe and South Africa. Reviews of UrbanSim and comparison to other urban modeling platforms may be found in references.

<span class="mw-page-title-main">Traffic simulation</span>

Traffic simulation or the simulation of transportation systems is the mathematical modeling of transportation systems through the application of computer software to better help plan, design, and operate transportation systems. Simulation of transportation systems started over forty years ago, and is an important area of discipline in traffic engineering and transportation planning today. Various national and local transportation agencies, academic institutions and consulting firms use simulation to aid in their management of transportation networks.

Paramics is traffic microsimulation software, originally developed by Quadstone Ltd. There is a related pedestrian microsimulation product called the Urban Analytics Framework.

The Survey on Household Income and Wealth (SHIW) is a statistical survey conducted by the Sample Surveys Division of the Banca d'Italia . The main objective of the SHIW is to study the economic behaviours of Italian households. In recent years the survey has been integrated in international research projects such as the Luxembourg Income Study and the Luxembourg Wealth Study, whose aim is to produce a comparable cross-national Data Archive on household income and wealth. Starting from 2008, the survey has also been part of a project conducted by the European Central Bank to produce a harmonized survey on household finances and consumption in the Euro area.

TARKI Social Research Institute is an independent research centre located in Budapest, Hungary. TARKI conducts applied socioeconomic research in social stratification, labour markets, income distribution, intergenerational transfers, tax-benefit systems, consumption and lifestyle patterns and attitudes in Hungary and, in the majority of its projects, in Europe. TARKI is closely embedded in international collaborations with major European academic partners in various research projects. Senior staff at TARKI all have PhDs with substantive and methodological interests and many hold professorial appointments at major universities. TARKI has its own fieldwork apparatus, capable of carrying out regular empirical surveys on social structure and on attitudes and of managing large scale international research. TARKI also carries out the Hungarian fieldwork of various high-quality international surveys.

Tax policy and economic inequality in the United States discusses how tax policy affects the distribution of income and wealth in the United States. Income inequality can be measured before- and after-tax; this article focuses on the after-tax aspects. Income tax rates applied to various income levels and tax expenditures primarily drive how market results are redistributed to impact the after-tax inequality. After-tax inequality has risen in the United States markedly since 1980, following a more egalitarian period following World War II.

For pensions, a reliable Pension model is necessary for system simulations and projections, so it is important to have a sound database for pension system analyses. For an example of a complex pension model see e.g..

A dynamic microsimulation pension model is a type of a pension model projecting a pension system by means of a microsimulation and generating the complete history of each individual in a data set. The results of such model offer both the aggregate and individual indicators of the pension system. Thanks to complexity of results, there is a possibility to investigate the distribution of pensions, poverty of pensioners, impact of the changes of the pension formula, for more examples see e.g.. Detailed individual set of (administrative) data should serve as a model input.

The Dynamic Microsimulation Model of the Czech Republic is a dynamic microsimulation pension model simulating the pension system of the Czech Republic, owned by the Ministry of Labour and Social Affairs.

<span class="mw-page-title-main">Southmod</span> Tax-benefit model

SOUTHMOD is a collection of tax-benefit models for countries in the Global South, maintained and managed by the United Nations University World Institute for Development Economics Research (UNU-WIDER) and partners. It belongs to the class of static microsimulation models and currently has modules for seven countries in Africa, four in Latin America, and one in Southeast Asia (Vietnam). The models are freely available for non-commercial research use.

References

  1. ↑ "UKMOD: A new tax-benefit microsimulation model for the UK". Institute for Social and Economic Research (ISER). Retrieved 2023-03-04.
  2. ↑ Williamson, Paul (2007). "The role of the International Journal of Microsimulation". International Journal of Microsimulation. 1 (1): 1–2. doi: 10.34196/ijm.00001 .
  3. 1 2 SUTHERLAND, Holly. Constructing a Tax-Benefit Model: What Advice Can One Give?. Review of Income [online]. 1991, 37(2), 199-219 [cit. 2018-05-02]. ISSN 0034-6586.
  4. ↑ Bourguignon, François; Spadaro, Amedeo (2006-04-01). "Microsimulation as a tool for evaluating redistribution policies". The Journal of Economic Inequality. 4 (1): 77–106. CiteSeerX   10.1.1.639.3750 . doi:10.1007/s10888-005-9012-6. ISSN   1569-1721. S2CID   721052.

Selected models' websites

This page is based on this Wikipedia article
Text is available under the CC BY-SA 4.0 license; additional terms may apply.
Images, videos and audio are available under their respective licenses.