Overview of the Tax Foundation’s General Equilibrium Model

Executive Summary

The TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation uses and maintains a General Equilibrium Model, known as our Taxes and Growth (TAG) Model to simulate the effects of government tax and spending policies on the economy and on government revenues and budgets. The model can produce both conventional and dynamic revenue estimates of tax policy. The model can also produce estimates of how policies impact macroeconomic aggregates such as gross domestic product (GDP), wages, employment, the capital stock, investment, consumption, saving, and the trade deficit. Lastly, it can produce estimates of how different tax policies impact the distribution of the federal tax burden. The model can analyze the effects of most types of taxes. It can estimate the effects of changes to the rate and the base of the individual income taxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. , the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. , payroll taxes, taxes on wealth like estate and gift taxes, and excise taxes.

The Tax Foundation model has three main components that work together to produce estimates. The first component is a tax simulator, which produces conventional revenue and distributional estimates as well as estimates of marginal tax rates on different sources of personal and business income. The second component is a neoclassical production function, which estimates long-run changes in the level of output based on changes in the capital stock and labor force in response to policy. The last component is an allocation model, which takes outputs from the tax and production models and combines with aggregate accounting identities and saving responses to forecast the different components of GDP, the balance between saving and investment, the international account, wealth, and gross national product (GNP).

The Tax Foundation model produces estimates of the long-run impact of tax policy as well as the year-by-year path of the economic adjustment and the impact of tax policy on the government budget over the usual 10-year budget window.

February 2025 Update

Key Improvements to Our Model

• First, on an annual basis, we update the underlying baseline data in the model using the Congressional Budget Office baseline. Our model now reflects the January 2025 baseline, which projects larger tax and economic variables than last year’s baseline. Both changes impact the revenue estimates we produce. While we have updated to the new baseline, our model still retains the ability to simulate tax policy changes within the 2025 through 2034 budget window.
• Second, we implemented a matched database. We augmented our tax data input by statistically matching data from the Current Population Survey (CPS) from Census. The expanded data brings imputed demographic information, such as age and gender, as well as income splits for joint filers. With income split information among joint filers, we enhanced our payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. model and fully integrated it with our individual income tax simulator. The matched database also allows us to model certain policy proposals that would convert nonfilers into tax filers.
• On top of that, we improved our distribution table by measuring simulated tax changes over an expanded definition of income instead of over adjusted gross incomeFor individuals, gross income is the total pre-tax earnings from wages, tips, investments, interest, and other forms of income and is also referred to as “gross pay.” For businesses, gross income is total revenue minus cost of goods sold and is also known as “gross profit” or “gross margin.” (AGI).
• Third, we’ve completed changes to our user cost of capital as detailed in our prior research paper here. The user cost of capital formula separates the required rate of return for businesses and individual savers. Tax Foundation continues to model the US as a small open economy, which means that the US is fully open to foreign capital inflows to finance private investment and public debt and that the long-run after-tax rate of return on business assets is fixed. Other models take a different approach: for example, the Joint Committee on Taxation has moved toward a partially open economy assumption while the Congressional Budget Office incorporates large crowd-out effects. Ultimately, no model provides a perfect representation of the real world, yet each sheds light on different aspects that impact the fiscal debate.
• Finally, the Tax Foundation has constructed a more detailed model of corporate federal tax liabilities. The model uses a set of representative firms and data from the Internal Revenue Service and the Bureau of Economic Analysis to produce detailed corporate tax liability and effective tax rate estimates by industry, firm type, and country of corporate residence. We are now able to capture details such as profit shiftingProfit shifting is when multinational companies reduce their tax burden by moving the location of their profits from high-tax countries to low-tax jurisdictions and tax havens. responses, general business credits, and key provisions such as the treatment of subpart F income, global intangible low-taxed income (GILTI), and income that qualifies for the foreign derived intangible income (FDII) deduction. Even with more details on the corporate model, however, modeling the economic and revenue effects of policies that impact cross border investment remains subject to a high level of uncertainty, not least of which is that the effects partially depend on an assumption that foreign tax policies remain stable. We can simulate new provisions, such as the corporate alternative minimum tax (CAMT) and stock buyback tax, both enacted into law in 2022, using company-level financial statement data that is synced with our broader corporate model. The corporate tax model also provides a detailed way to simulate changes to depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. deductions by asset type.

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