Macroeconomic and Distributional Effects of Personal Income Tax Reforms: A Heterogenous Agent Model Approach for the U.S
IMF Working Papers, September 1, 2017
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- Macroeconomic and Distributional Effects of Personal Income Tax Reforms: A Heterogenous Agent Model Approach for the U.S
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Bibliographic details
- Authors: Sandra Lizarazo, Damien Puy
- Published: September 1, 2017
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781484316580.001
Methodology and model setup
- Multi-sector heterogenous agents model calibrated to key characteristics of the US economy.
- Consumers have non-homothetic preferences.
- Sectors differ in relative labor and skill intensity.
- Focus on personal income tax (PIT) reforms and interactions with consumption taxes and the Earned Income Tax Credit (EITC).
Core findings
- PIT cuts stimulate growth but the supply side effects are never large enough to offset the revenue loss from lower marginal tax rates.
- PIT cuts do “trickle-down” the income distribution: tax cuts stimulate demand for non-tradable services which raise the wages and employment prospects of low-skilled workers even if the tax cut is not directly incident on them.
- A revenue neutral tax plan that reduces PIT for middle-income groups, raises the consumption tax, and expands the Earned Income Tax Credit can have modestly positive effects on growth while reducing income polarization.
- The growth effects from lower income taxes are concentrated in non-tradable service sectors, although the increased demand for tradable goods generate positive spillovers to other countries.
- Tax cuts targeted to higher income groups have a stronger growth impact than tax cuts for middle income households but significantly worsen income polarization, even after taking into account trickle-down effects and an expansion of the Earned Income Tax Credit.
Policy implications and scenarios
- Revenue cost: PIT cuts raise growth but do not fully pay for themselves through supply-side responses—policy design must account for revenue shortfalls from lower marginal rates.
- Distribution-sensitive design: A revenue-neutral combination of middle-income PIT reductions, higher consumption taxes, and expanded EITC can modestly boost growth while reducing income polarization.
- Trade-offs: Targeting tax cuts to higher-income groups yields larger growth gains but exacerbates income polarization; targeting middle-income groups is more distribution-friendly with smaller growth trade-offs.
- Sectoral considerations: Because growth effects concentrate in non-tradable services, assessment of PIT reforms should consider sectoral labor intensity and international spillovers through tradable goods demand.
Content in this bundle
- Macroeconomic and Distributional Effects of Personal Income Tax Reforms, WP/17/192, September 2017