MACROECONOMIC ANALYSIS OF A PROPOSAL TO BROADEN 

THE INDIVIDUAL INCOME TAX BASE AND LOWER 

INDIVIDUAL INCOME TAX RATES 

Prepared by the Staff 

of the 

JOINT COMMITTEE ON TAXATION 

December 14, 2006 

JCX-53-06
i

CONTENTS 

Page

INTRODUCTION AND SUMMARY........................................................................................... 1 

I. DESCRIPTION OF THE PROPOSAL CONSIDERED AND THE 

 MACROECONOMIC MODELS USED FOR THE ANALYSIS ........................................ 2 

A. Description of Proposal................................................................................................... 2 

B. Description of Macroeconomic Simulation Models Used in the Analysis..................... 4 

II. RESULTS .............................................................................................................................. 9 

A. Effects on Real Gross Domestic Product...................................................................... 10 

B. Effects on the Capital Stock.......................................................................................... 11 

C. Effects on Private Sector Employment......................................................................... 14 

D. Effects on Consumption................................................................................................ 15 

E. Conclusion .................................................................................................................... 16 

REFERENCES ............................................................................................................................. 17 
1

INTRODUCTION AND SUMMARY 

This document,1

 prepared by the staff of the Joint Committee on Taxation (“Joint 

Committee staff”), provides an analysis of the macroeconomic effects of a proposal to modify 

the individual income tax by broadening the tax base and reducing statutory tax rates. In 

particular, the proposal would eliminate exemptions and reduce deductions and credits. It would 

reduce tax rates and repeal the alternative minimum tax (“AMT”). The proposal is 

approximately revenue neutral as measured by the conventional revenue estimate over the 

current 10-year budget window. 

The Joint Committee staff analyzed this proposal utilizing three different macroeconomic 

models: the Joint Committee staff macroeconomic equilibrium growth model (“MEG”), an 

overlapping generations lifecycle model (“OLG”), and a dynamic stochastic general equilibrium 

model with infinitely lived agents (“DSGE”). In general, the lower marginal rates made possible 

by the base broadening provide additional incentives for work and investment, which are 

expected to result in an increase in real gross domestic product, business investment, and 

employment. Investment in housing is likely to be reduced by the proposal. The extent of the 

changes depends on the sensitivity of individual labor choices to changing marginal rates, as well 

as on how the proposal affects the overall Federal government debt and interest rates. Two of 

the models suggest that consumption would increase as a result of the proposal; however, the 

third suggests that consumption would decrease because of a redistribution of individual income 

tax liability from high wage earners to low wage earners. 

This study is part of the Joint Committee staff’s work to model the macroeconomic 

effects of proposed tax legislation and to provide information about macroeconomic models and 

their assumptions. The Joint Committee staff welcomes comment on this analysis. 

 1

 This document may be cited as follows: Joint Committee on Taxation, Macroeconomic 

Analysis of a Proposal to Broaden the Individual Income Tax Base and Lower Individual Income Tax 

Rates, (JCX-53-06), December 14, 2006. 
2

I. DESCRIPTION OF THE PROPOSAL CONSIDERED AND THE 

MACROECONOMIC MODELS USED FOR THE ANALYSIS 

A. Description of Proposal 

A broad-base, low tax rate individual income tax

Under the proposal, all personal exemptions, itemized deductions, personal credits except 

for the earned income credit, and all above-the-line adjustments to income except for retirement 

savings deductions and the deduction for self employment taxes would be repealed. The largest 

categories of deductions repealed are present-law deductions for home mortgage interest 

expenses, State and local taxes, and charitable contributions. In addition, the exclusions for 

certain employee fringe benefits, such as employer contributions for health and life insurance, 

would be repealed. The standard deduction would remain. 

The proposal would reduce tax rates relative to present law. The statutory rates that 

apply to ordinary income in 2007 are reduced by approximately 23.5 percent. Under present 

law, statutory tax rates on individual ordinary income form the following progressive structure 

through six tax brackets: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 

percent. The bracket amounts would correspond to those specified under present law through 

2010. For taxable years beginning after December 31, 2010, this structure reverts to a five 

bracket structure with the following statutory tax rates on ordinary income: 15 percent, 28 

percent, 31 percent, 36 percent, and 39.6 percent. Under the proposal, broadening the tax base 

would allow for the repeal of the alternative minimum tax and a reduction in the present law 

statutory rates applicable to ordinary income. Specifically the new rates would be 7.55 percent, 

11.5 percent, 19.1 percent, 21.4 percent, 25.2 percent and 26.8 percent. The taxation of capital 

gains and dividends remains unchanged. The new rate structure is assumed to be permanent and 

effective for taxable years beginning after December 31, 2006. Table 1 provides a summary of 

individual ordinary income tax rates by 2007 income bracket for 2007 and 2016 under present 

law, and for the entire period under the proposal. 

Table 1.−Statutory Tax Rates Under Present Law and Proposal 

2007 Income Brackets 

for 

Single Filers 

(estimated) 

2007 Income Brackets 

for 

Joint Filers 

(estimated) 

2007-2010 

Statutory 

Tax Rates 

(present law)

Statutory 

Tax Rates 

After 2010 

(present law) 

Proposed 

Statutory 

Tax Rates 

<$7,775 <$15,551-$63,200 10 15 7.55 

$7,776-$31,600 $15,551-$63,200 15 15 11.55 

$31,601-$76,550 $63,201-$127,600 25 28 19.1 

$76,551 - $159,700 $127,601-$194,450 28 31 21.4 

$159,701-$347,250 $194,451-$347,250 33 36 25.2 

>$347,250 >$347,250 35 39.6 26.8 
3

Conventional estimate of the effects of the proposal - long run and short-run

Using our conventional revenue estimating methodology, the individual income tax as 

modified by the proposal is expected to result in approximately the same amount of Federal 

individual income tax receipts during the 2007-2016 budget period as the present law individual 

income tax. Because of the changing rate structure within the ten-year budget period under 

present law, the effect of this new permanent rate structure under the proposal is to raise 

revenues relative to present law for the period 2007-2010 and to lose revenues relative to present 

law during the period from 2011-2016 and thereafter. The reason for the continuing revenue 

losses relative to present law is that the present-law tax rate structure results in receipts growing 

more rapidly than the economy after 2016--primarily because increasing numbers of taxpayers 

become subject to the alternative minimum tax.2

 But the new tax base and rate structure under 

the proposal, which does not include the alternative minimum tax, does not produce a 

corresponding rate of increase in revenues after 2016. Because receipts are lower in the long 

run, the proposal results in growing government debt relative to present law tax receipts in the 

long run. This result affects the analysis of the macroeconomic effects of the proposal, as will be 

discussed further in Part II. 

 2

 Under present law, there is a temporary increase in AMT liability between 2007 and 2010, 

while ordinary income tax rates remain low and the ability to apply certain personal credits against the 

individual AMT has expired. When ordinary income tax rates increase in 2011, the number of people 

subject to AMT falls, but gradually increases with nominal income growth. 
4

B. Description of Macroeconomic Simulation Models Used in the Analysis 

In order to account for the sensitivity of the analysis to different modeling assumptions, 

we have used three different models to simulate the macroeconomic effects of this proposal. The 

three models are the Joint Committee macroeconomic equilibrium growth model (“MEG”), an 

overlapping generations lifecycle model (“OLG”),3

 and a dynamic stochastic general equilibrium 

growth model with infinitely lived agents (“DSGE”).4 Following is a brief description of each 

model.

Macroeconomic equilibrium growth (“MEG”) model

The MEG model is based on the standard, neoclassical assumption that the amount of 

output is determined by the availability of labor and capital, and in the long run, prices adjust so 

that demand equals supply. Individuals are assumed to make decisions based on observed 

characteristics of the economy, including current period wages, prices, interest rates, tax rates, 

and government spending levels. Consumption in MEG is determined according to the life-cycle 

theory, which implies that individuals attempt to even out their consumption patterns during their 

lifetimes. Business production and housing production are modeled separately, and may 

substitute for each other. The model is an open economy model, allowing international capital 

flows to affect investment and net exports to affect U.S. consumption. 

The supply of labor to the economy over time is determined by the size of the working 

age population and that population’s willingness to work in response to changes in after-tax 

wages. Population and age profile projections are calibrated to the Census Bureau middle-series 

projections.5

 The path of Federal government expenditures on the two largest transfer payment 

programs, Social Security and Medicare, is calibrated to be between the low and intermediate 

projections in the Congressional Budget Office forecast in The Long-Term Budget Outlook,

December 2005. 

Individuals in the MEG model do not anticipate changes in the economy or government 

finances; thus, this type of model is often referred to as a “myopic” behavior model. This feature 

 3

 The OLG model is leased from Tax Policy Advisers, LLC. 

4

 More detailed descriptions of the MEG and OLG models and their assumed behavioral 

parameters may be found in: Joint Committee on Taxation, Macroeconomic Analysis of Various 

Proposals to Provide $500 Billion in Tax Relief, (JCX-4-05), March 1, 2005, and Joint Committee on 

Taxation, Overview of the Work of the Staff of the Joint Committee on Taxation to Model the 

Macroeconomic Effects of Proposed Tax Legislation to Comply with House Rule XIII.3(h)(2), (JCX-105-

03), December 22, 2003. A more detailed description of the DSGE model may be found in Joint 

Committee on Taxation, Background Information about the Dynamic Stochastic General Equilibrium 

Model Used by the Staff of the Joint Committee on Taxation in the Macroeconomic Analysis of Tax 

Policy, (JCX-52-06), December 14, 2006. 

5

 United States Census Bureau, U.S. Interim Projections by Age, Sex, Race, and Hispanic Origin. 

U.S. Census Bureau, Population Division, Population Projections Branch, March 2004. 
5

of the MEG model allows the simulation of tax and government expenditure policy that may 

result in an unsustainable growth path. Specifically, policies that result in the Federal debt 

increasing or decreasing at a faster rate than the growth of gross national product (“GNP”) can be 

modeled. This feature allows the MEG model to incorporate in its simulations a baseline fiscal 

policy that is consistent with present law for a period far beyond the 10-year budget planning 

period. 

The analysis below presents three different simulations using the MEG model. All three 

simulations assume that the Federal Reserve Board acts aggressively to offset any short-run 

demand effects that may result from changes in Federal government debt. Because all three 

simulations also allow government debt to grow with no fiscal policy offset beyond the ten-year 

budget period, the Federal Reserve Board adjusts interest rates upward. The first simulation uses 

the standard MEG default labor supply response parameters, as described in our earlier work. 

The second MEG simulation uses lower labor supply response parameters.6

 The final MEG 

simulation uses the default labor supply response, but changes the policy experiment to permit 

the mortgage interest deduction, while using the same new statutory tax rates that are used in the 

other policy simulations. This simulation is included to provide an indication of the importance 

of the housing sector response to overall macroeconomic results; however, because this version 

of the proposal raises less revenue than the other versions, the simulation results also reflect the 

differential effects on the path of government debt. 

Overlapping generations life cycle (“OLG”) model

In the OLG model, individuals are assumed to make consumption and labor supply 

decisions in order to maximize their lifetime well-being given the resources they anticipate will 

be available to them. They are assumed to have complete information, or “perfect foresight,” 

about economic conditions, such as wages, prices, interest rates, tax rates, and government 

spending, over their lifetimes. The economic decisions are modeled separately for each of 55 

adult-age cohorts. 

The OLG model has separate production sectors for business and housing. This feature 

allows for an analysis of the effects of the different policies on the allocation of investment 

between housing and business. Unlike the MEG model, the OLG model also treats the purchase 

of housing as a consumption decision, thus making investment in housing less responsive to 

changes in the after-tax price of housing. Also unlike the MEG model, the OLG model assumes 

that prices adjust to any changes in economic conditions (such as a change in fiscal policy) so 

that supply equals demand in every period and resources are always fully utilized, after 

accounting for the cost of adjusting the capital stock. Therefore, the model does not allow for 

unemployment, but does account for adjustment costs that would be related to changes in the rate 

of investment and the movement of assets between sectors during the transition. There is no 

explicit modeling of international trade in goods and services, but international capital flows are 

modeled through interest rate adjustments. 

 6

 These parameters appear in Joint Committee on Taxation, 2005, op.cit., p.57. 
6

Under present law, although normal income growth is expected to increase AMT receipts 

significantly, the changing age profile of the population is expected to increase transfer payments 

even more significantly, and Federal government debt is expected to grow at a faster rate than 

the economy in the coming decades.7

 In macroeconomic modeling, government debt growing at 

a faster pace is often referred to as fiscal instability. The overlapping generations and perfect 

foresight features of the OLG model make it difficult to model changing age profiles of the 

population and the fluctuating path of Federal government debt created by the combined 

changing profile of AMT receipts and transfer payments. The dynamic general equilibrium 

feature makes it impossible to model the long-run fiscal instability created by the rapid growth in 

Federal government debt. Therefore, the OLG model simulations do not incorporate a long-run 

increase in government debt due to the policy, as the other model simulations do. The proposal 

is revenue neutral across the whole budget horizon. The two simulations presented in this 

analysis assume either that individual ordinary income tax rates are set each period to preserve 

revenue neutrality or that Federal government transfer payments are changed to offset changes in 

revenues. In general, these assumptions result in either a smaller decrease in marginal tax rates 

than is simulated in the MEG simulations, or a reduction in government transfer payments. 

Dynamic Stochastic General Equilibrium Model (“DSGE”) 

The DSGE model has microeconomic foundations, based on the neoclassical growth 

framework. Similar to the OLG model, the DSGE model assumes that the economy operates at 

full employment each period, and therefore it does not model involuntary unemployment or the 

effects of policy on unemployment. In contrast to the MEG and OLG models, in the DSGE 

model the amount of foresight people have about future fiscal policy can vary; foresight may be 

myopic or perfect, or somewhere in between. In this analysis, the simulations assume that every 

year agents know the exact tax policy next year, and that people forecast that tax policy after the 

next year is likely to be persistent with some random disturbances. The model is a closed, real 

economy. 

The model distinguishes between two types of people: those who save (“savers”) and 

those who do not (“spenders”). Savers decide how much to save by optimizing their 

consumption utility over time subject to a budget constraint. They own the entire capital stock of 

the economy and also hold government debt. Spenders consume all disposable income each 

period; they do not own capital and therefore cannot lend capital. In equilibrium, neither savers 

nor spenders borrow to finance consumption or investment. Generally consistent with empirical 

evidence, spenders are assumed to be those in the lower portion of the income distribution. We 

assume in the model that spenders are those in the bottom 40th percentile of filers with positive 

labor income. This partitioning between spenders and savers allows for an analysis of the 

differential effects of proposals on relatively low and high income households. 

Government in the model can operate at permanently increasing debt levels due to a tax 

cut as long as the economy grows at a faster rate than the debt, thus maintaining fiscal solvency. 

For this analysis, the Federal government responds to increases in debt by reducing either its 

spending on goods and services (“consumption”) or its transfer payments with a ten-year delay. 

 7

 Congressional Budget Office, The Long-Term Budget Outlook, December 2005. 
7

The model has one production sector; no distinction is made between residential capital 

and production capital. There is one effective capital income tax rate, which is computed as the 

income-weighted average of effective tax rates on income from corporate and non-corporate 

capital as derived from the Joint Committee staff individual income tax and corporate income tax 

microsimulation models. 

Modeling limitations

The Joint Committee staff presents multiple macroeconomic simulation models when 

analyzing tax proposals because no one model framework can provide complete information 

about the broad array of anticipated effects of tax policy on the economy. Even with this 

multiple model approach, however, we cannot account for all the possible effects that this 

proposal might have on the economy. 

Effects on the housing sector

The elimination of deductions for mortgage interest and property tax expenses for 

homeowners in this proposal is likely to impact housing markets significantly. 

Because there is no separately modeled housing sector in the DSGE model, simulations 

of this model do not capture any effects of the proposal that would be unique to housing markets. 

Both the MEG and OLG models include separate housing sectors for business investment, 

allowing them to provide some information on the impact of the proposal on housing versus 

substitute investments. Still, there are a number of issues that are not completely addressed by 

these models, either because there is little consensus as to the correct approach or because the 

models are not currently well suited to the question. In the MEG model, housing is treated as 

strictly an investment, and the consumption value of housing is not modeled. This feature 

implies that the full economic cost of reducing the housing stock is understated and the 

representative agents do not suffer a loss in well-being due to consuming less housing. Thus, in 

the MEG model, shifting between the housing stock and business capital is easier than we might 

expect. By contrast, in the OLG model, the consumption value of housing and adjustment costs 

associated with switching investment out of the housing sector are modeled. As can be seen in 

the results below (Tables 3 and 4), there is a smaller shift from the housing stock to business 

capital in the OLG model than in the MEG model. 

Further, neither the MEG nor OLG model includes a portfolio allocation algorithm that 

would allow for analysis of the likely effects of denial of the mortgage interest deduction on 

refinancing or other portfolio decisions. As housing prices adjust, there are potentially 

significant financial market effects that would likely be felt by both home owners and owners of 

capital, particularly if there are significant defaults. Neither model explicitly accounts for the 

effect of possible declines in housing prices on the household wealth. Such an analysis would be 

necessary to fully model the effects of the proposal on mortgage interest rates and housing 

prices. Since for many consumers the value of their house is the single largest item in household 

wealth, any reduction in the value of the house would diminish wealth, which would potentially 

lower consumption. 
8

Effects on the healthcare and health insurance sectors

Another major feature of this proposal is the denial of the income tax exclusion for 

employer-provided health insurance, along with the denial of the deduction of health-related 

expenditures by individuals as consumers of health services. These features of the proposal 

could have a significant impact on the 15 percent of the economy that the healthcare sector 

represents. While firms would continue to be able to deduct health-care expenses, the after-tax 

cost of health care would be increased because these expenses would be taxable to individuals, 

making health care relatively more expensive to consume. The likely reduced demand for health 

care could result in pressure for health service providers to lower costs, thus increasing efficient 

provision of health care services. The increase in the after-tax cost of health care is also likely to 

decrease consumption of health care, thus shifting investment away from health care and into 

other sectors of the economy, which could improve economic efficiency. However, it could also 

reduce the rate of progress in medical advances, thus affecting long-run human capital 

development. There are also potentially significant effects on the insurance sector. None of the 

changes in the health care or insurance sectors is modeled in these simulations, largely because 

there is little economic consensus regarding the effects, but also because significant and timeconsuming modeling changes would be required. 

Other effects

In general, the base-broadening nature of this proposal means that special tax incentives 

will be lost for many specific activities, e.g., childcare, education, adopting children, spending on 

home improvements to increase energy efficiency, and making charitable contributions. This 

analysis does not attempt to account for the effects of the proposal on these activities, some of 

which may have some feedback into the economy. 

In particular, there are potential effects of the proposal on labor supply, particularly of 

secondary earners, that are not entirely captured in the models. Lower tax rates increase the 

incentive to work by increasing the marginal benefit of labor, thus causing people to substitute 

labor for leisure; but the elimination of dependent care credits and inclusion in income of the 

value of employer-provided child care increase the after-tax cost of working. While the effects 

of the tax rate changes are captured in the models, and while secondary labor supply is explicitly 

modeled in the MEG model, none of the models explicitly accounts for the increased after-tax 

cost of work-related expenses. 

In addition, there are potential effects of the proposal on the incentive to invest in human 

capital, which has been associated empirically with productivity, growth, and investment. Lower 

marginal tax rates increase this incentive, while elimination of some of the education subsidies 

may have the opposite effect. The macroeconomic models used in this analysis do not include 

human capital, and so may understate or overstate overall growth effects of the proposal. 
9

II. RESULTS 

Following is a series of tables that show the effects of this proposal on real (inflation 

adjusted) gross domestic product (“GDP”), real business and residential capital stock, 

employment, labor supply, and consumption. 

Results from each policy simulation for each variable are presented as percentage 

changes from the present-law baseline forecast values for the variable. Specifically, the 

percentage change in each variable for the first five years is calculated by summing the change in 

the reported variable due to the proposal over the period from 2007 to 2011, and dividing that 

change by the sum of the baseline values of each variable over the same period. The same 

calculation is applied to the period from 2012 to 2016. The Joint Committee staff configures the 

present-law baseline forecasts for Federal government receipts and spending in each of the 

macroeconomic models to approximate the January 2006 forecast of the Congressional Budget 

Office8

 as closely as possible. The baseline beyond 2016 is extrapolated to approximate longrun expected Federal government receipts and expenditures under present-law as closely as 

possible within each model, subject to the constraints resulting from requirements for 

maintaining a steady-state equilibrium in the OLG model, and to a lesser extent the DSGE 

model. While it is impossible to incorporate unknowable intervening circumstances, such as 

major resource or technological discoveries or shortages, these models are designed to predict 

the long-run effects of policy changes, assuming other unpredictable influences are held 

constant. To provide information about the longer run effects of the policy, the tables also report 

the percent change in each economic variable in 2034, which is referred to in the tables as “long 

run.”9

 8

 Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007-2016,

January 2006. 

9

 The year 2034 was selected as the “long-run” for the purpose of these simulations, 

primarily for consistency with prior reported results. In general, we are constrained in our choice 

of a year to represent the long run by how far into the future our myopic models will continue to 

converge. For baseline, present-law simulations, our models continue to converge until at least 

2050. But for some policy simulations we have considered, the models begin to have difficulty 

converging in the early 2040’s. By choosing a year that is about half a decade earlier, we avoid 

reporting results that are influenced by nonconvergent model behavior. At the same time, by the 

mid-2030’s, essentially all of the “baby boomers” will have retired and are making full use of 

Social Security and Medicare, and thus the models will be significantly influenced by this 

important long-run demographic dynamic. 
10

A. Effects on Real Gross Domestic Product 

Table 2.–Percent Change in Real GDP Relative to Present Law 

Percent Change in Real GDP 2006-11 2012-16 Long Run 

 MEG, Base Elasticity 1.1 1.9 0.9 

 MEG, Low Labor Elasticity 0.9 1.6 0.2 

 OLG, Transfer Offset 1.2 1.9 2.6 

 OLG, Tax Rate Offset 1.2 1.1 1.2 

 DSGE, Lagged Transfer Offset 0.1 1.2 3.5 

 DSGE, Lagged Government 

 Consumption Offset 0.1 1.2 2.5 

 MEG, Keep Housing Deductions 0.8 1.6 0.5 

Real gross domestic product is increased by the proposal in all of the simulations. In the 

short-run, the increase ranges from 0.1 percent of GDP to 1.2 percent of GDP, while in the longrun, the increase ranges from 0.2 percent to 3.5 percent. Growth in the MEG and OLG models 

responds to changes in average and marginal tax rates on labor, changes in the after-tax return to 

capital, and changes in the after-tax cost of housing capital versus the after-tax cost of producers’ 

capital. In the DSGE simulations, the amount of growth is determined by labor supply response 

to changes in disposable income and in marginal tax rates on labor, differentiated between 

spenders and savers, and by investment response to changes in the after-tax cost of capital; there 

is no substitution from housing to producers’ capital. Within the 10-year budget period, growth 

is higher in the MEG and OLG simulations both because of a bigger labor response to changes in 

marginal tax rates and because of substitution from investment in housing to investment in 

producers’ capital. In the long run, growth in the MEG simulations is lower than in simulations 

of the other two models because the increasing government debt crowds out private sector 

investment. Growth is higher in the OLG and DSGE simulations that use transfer payments as 

fiscal offsets because the reduction in transfer payments lowers disposable income, thus creating 

additional incentives to work. The tax rate offset in the longer-run OLG simulations reduces the 

marginal rate stimulus for both labor and capital relative to the proposal, which is revenue 

neutral only within the budget window. 
11

B. Effects on the Capital Stock 

Table 3.–Percent Change in Total Real Capital Stock Relative to Present Law 

Percent Change in Total Capital 2006-11 2012-16 Long Run 

 MEG, Base Elasticity -0.2 -0.9 -7.3 

 MEG, Low Labor Elasticity -0.2 -1.0 -8.0 

 OLG, Transfer Offset 0.5 2.0 4.5 

 OLG, Tax Rate Offset 0.2 1.1 1.8 

 DSGE, Lagged Transfer Offset 0.5 2.4 7.2 

 DSGE, Lagged Government 

 Consumption Offset 0.5 2.3 5.5 

 MEG, Keep Housing Deductions 0.2 -0.3 -6.8 

Table 4.–Percent Change in Real Producers’ Capital Relative to Present Law 

Percent Change in Producers’ Capital 2006-11 2012-16 Long Run 

 MEG, Base Elasticity 2.7 5.3 2.5 

 MEG, Low Labor Elasticity 2.6 5.0 1.7 

 OLG, Transfer Offset 1.9 5.5 9.8 

 OLG, Tax Rate Offset 0.5 1.9 3.1 

 DSGE, Lagged Transfer Offset 0.5 2.4 7.2 

 DSGE, Lagged Government 

 Consumption Offset 0.5 2.3 5.5 

 MEG, Keep Housing Deductions 1.2 2.9 -0.8 
12

Table 5.–Percent Change in Real Residential Capital Relative to Present Law 

Percent Change in Residential Capital 2006-11 2012-16 Long Run 

 MEG, Base Elasticity -3.0 -7.2 -19.3 

 MEG, Low Labor Elasticity -3.0 -7.3 -20.0 

 OLG, Transfer Offset -1.2 -2.2 -1.9 

 OLG, Tax Rate Offset -0.2 0.0 0.3 

 DSGE, Lagged Transfer Offset n.a. n.a. n.a. 

 DSGE, Lagged Government 

 Consumption Offset n.a. n.a. n.a. 

 MEG, Keep Housing Deductions -0.9 -3.5 -14.1 

Table 6.–Change in Interest Rates Relative to Present Law 

Change in Real Interest Rates (Basis Points) 2006-11 2012-16 Long Run 

 MEG -52 -30 104 

 MEG, Low Labor Elasticity -52 -30 114 

 OLG, Transfer Offset 1.5 122 0 

 OLG, Tax Rate Offset 67 64 0 

 DSGE, Lagged Transfer Offset 4 17 19 

 DSGE, Lagged Government 

 Consumption Offset 5 17 24 

 MEG, Keep Housing Deductions -19 2 191 

The proposal results in an increase in producers’ capital stock in virtually all of the 

simulations. The MEG and OLG models distinguish between producers’ capital and residential 

capital; thus, changes in the total capital stock can be small or even negative while GDP growth 

is still boosted by increases in producers’ capital stock, as shown in Tables 3 and 4. In the 

DSGE model, producers’ capital and total capital are synonymous. In the short run, the increase 

in producers’ capital is largest in the MEG simulations, which show a correspondingly larger 

decrease in residential capital stock. The interest rate changes shown in Table 6 reflect the 

impact of differing long-run fiscal policy assumptions; these differences correspond with the 

differences in long-run capital stock growth among the three models. In the long run in the MEG 

simulations growth in producers’ capital stock is depressed because of the crowding out effects 

of the rapidly growing Federal government debt, leading to long-run increases in the interest rate. 

In the DSGE simulations, Federal government debt is also allowed to grow, but only so long as it 
13

does not outpace the growth of GDP. Consequently, there is a smaller increase in interest rates, 

less crowding out, and a net growth in investment. Because the OLG simulations do not allow 

for an increase in debt relative to GDP, there is no long-run change in interest rates, and hence a 

greater growth in the stock of business capital. 

The OLG model shows a smaller response of residential capital than the MEG model, in 

part because OLG models the consumption value of housing and the adjustment costs of 

transitioning investment out of housing. As Table 5 shows, when this substitution is explicitly 

modeled, the stock of residential capital can be expected to fall. Investment in producers’ capital 

is higher in both the OLG and DSGE simulations that use transfer payments to offset the longrun growth in government debt because the labor supply response is the highest in these 

simulations. 
14

C. Effects on Private Sector Employment 

Table 7.–Percent Change in Private Sector Employment Relative to Present Law 

Percent Change in Private Sector Employment 2006-11 2012-16 Long Run 

 MEG, Base Elasticity 1.0 1.7 2.5 

 MEG, Low Labor Elasticity 0.7 1.3 2.0 

 OLG, Transfer Offset 1.1 0.8 0.4 

 OLG, Tax Rate Offset 1.4 0.9 0.6 

 DSGE, Lagged Transfer Offset 0.0 0.8 1.8 

 DSGE, Lagged Government 

 Consumption Offset 0.0 0.8 1.1 

 MEG, Keep Housing Deductions 0.9 1.6 2.6 

Although long-run employment increases in all the simulations, there is a significant 

range in the magnitude of the increase among the simulations, and the primary reasons for the 

increase differs between models. Both the MEG model and the DSGE model include separate 

labor supply functions for lower income versus higher income individuals, and the effects of the 

proposal’s change in statutory tax rates on effective marginal tax rates on labor income is 

computed separately for these different groups. Effective marginal rates on labor used in these 

models are computed using the Joint Committee staff’s individual income tax microsimulation 

model. These rates decrease less for the lower income groups than the others in the MEG model. 

In the DSGE model, because there is no distinction between average and marginal tax rates; the 

effective tax rates on labor increase for the lower wage group. Hence, in the early years after 

implementation of the proposal, there is very little direct incentive to increase labor effort for 

these groups, particularly in the DSGE model. In the second half of the budget period, there is 

an induced labor supply incentive from wage growth due to the increased capital stock. In the 

long run in the DSGE model, the simulation with lagged reduction in transfer payments induces 

more employment because the lower income group works more to make up for the loss of 

transfer payment income. The contrast in employment effects between the base case and the low 

labor elasticity simulation in the MEG model illustrates directly the influence of different 

assumptions about the degree of responsiveness built into models. 
15

D. Effects on Consumption 

Table 8.–Percent Change in Consumption Relative to Present Law 

Percent Change in Real Consumption 2006-11 2012-16 Long Run 

 MEG, Base Elasticity 1.5 3.3 4.0 

 MEG, Low Labor Elasticity 1.3 3.0 3.3 

 OLG, Transfer Offset 0.4 0.8 1.6 

 OLG, Tax Rate Offset 1.0 0.9 1.0 

 DSGE, Lagged Transfer Offset -0.6 -0.1 2.4 

 DSGE, Lagged Government 

 Consumption Offset -0.6 0.0 0.0 

 MEG, Keep Housing Deductions 0.9 2.6 3.2 

Consumption is presented as another indicator of the effects of the policy on peoples’ 

economic well-being. Although it is an over-simplification, most economic models equate 

increases in consumption with increases in individuals’ well-being. In the long-run, 

consumption increases in virtually all of the simulations. It increases most in the MEG 

simulations and least in the DSGE simulations. Because the decrease in housing investment in 

the OLG simulation is also modeled as a decrease in housing consumption, total consumption is 

not increased commensurately with the increase in GDP in the OLG model. 

In the DSGE simulation, consumption decreases within the window. Savers anticipate 

lower tax rates on capital income and hence reduce consumption to invest more, while spenders 

reduce consumption because of reductions in their disposable income due to higher tax liabilities. 

In the longer run, as savers become wealthier (in part due to returns from their increased 

investment), their consumption increases. In the simulation in which Federal government 

consumption is reduced to maintain fiscal solvency, consumption increases more because people 

tend to consume more when government absorbs a smaller share of resources. 
16

E. Conclusion 

Broadening of the individual income tax base through elimination of many preferences in 

the form of exclusions, deductions, and tax credits allows for a reduction in effective marginal 

tax rates for most individual income taxpayers. This policy also reduces preferential tax 

treatment of investment in housing relative to producers’ capital. Both of these effects provide 

incentives for more work and investment in the economy, thus increasing total output potential. 

The extent of this growth predicted in different macroeconomic model simulations can vary 

significantly depending on assumed behavioral parameters, the amount of disaggregation in the 

models between types of investment and types of workers and consumers, and assumptions about 

long-run fiscal policy in both the baseline model and the proposed policy change. 
17

REFERENCES 

Congresssional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007-

2016, January 2006. 

_____, The Long-Term Budget Outlook, December 2005. 

Joint Committee on Taxation, Background Information about the Dynamic Stochastic 

General Equilibrium Model Used by the Staff of the Joint Committee on Taxation in the 

Macroeconomic Analysis of Tax Policy, (JCX-52-06), December 14, 2006. 

_____, Macroeconomic Analysis of Various Proposals to Provide $500 Billion in Tax 

Relief (JCX-4-05) March 1, 2005. 

_____, Overview of the Work of the Staff of the Joint Committee on Taxation to Model 

the Macroeconomic Effects of Proposed Tax Legislation to Comply with House Rule XIII.3(h)(2), 

(JCX-105-03) December 22, 2003. 

United States Census Bureau, U.S. Interim Projections by Age, Sex, Race, and Hispanic 

Origin, United States Census Bureau, Population Division, Population Projections Branch, 

March 2004.