The HI and DI programs are modeled very simply. The Ш and DI levels of lump-sum transfers are picked to generate payroll tax rates of 2.9 percent and 1.9 percent, respectively, corresponding to their 1996 statutory rates. Like the OASI tax, DI contributions apply only to wages below $62,700. The HI tax, in contrast, is not subject to an earnings ceiling. Lump-sum HI and DI benefits are provided on an equal basis to agents above and below age 65, respectively.
Consumption taxes in the initial steady state reflect two elements of the existing tax structure. First we impose an 8.8 percent tax on consumption expenditures consistent with values reported in the National Income and Product Accounts on indirect business and excise revenues. However, because contributions to both defined benefit and defined contribution pension plans receive consumption tax treatment, we levy an additional 2.5 percent tax on household consumption goods expenditures to account for the indirect taxation of labor compensation in the form of pension benefits (Auerbach 1996). This 2.5 percent tax replaces the wage tax that otherwise would apply to labor compensation in the form of fringe benefits electronic-loan.com.
Social Security, Medicare and Disability
The model has a social insurance system that incorporates social security Old-Age and Survivors Insurance (OASI), Social Security Disability Insurance (DI), and public health insurance taking the form of Medicare (Ш).
Wage Income Taxation
The wage-income tax structure has four elements: 1) a progressive marginal rate structure derived from a quadratic approximation to the 1996 federal statutory tax rates for individuals, 2) a standard deduction of $4000 and exemptions of $5660 (which assumes 1.2 children per agent, consistent with the model’s population growth assumption), 3) Itemized deductions—applied only when they exceed the amount of the standard deduction—that are a positive linear function of income estimated from data reported in the Statistics of Income,s and 4) Eamings-ability profiles that are scaled up to incorporate pension and non-pension components of labor compensation.
The model’s initial economy-wide average marginal tax rate on wage income is about 21 percent, about the figure obtained from the NBER’s TAXSIM model reported in Auerbach (1996). The average wage-income tax rate equals 12.1 percent. For all individuals in the highest lifetime income class (group 12), the average effective marginal tax rate on labor income is 28.6 percent. The highest realized effective marginal tax rate is 34 percent. For lifetime income class 6—whose members have peak labor earnings of about $35,000—the average tax rate and average marginal tax rate are 10.6 and 20.0 percent, respectively. For the poorest class (group 1), the corresponding rates are zero and 5.5 percent.
The Non-Social Security Government Budget Constraint
At each time t, the government collects tax revenues and issues debt (Д+;) which it uses to finance government purchases of goods and services (G) and interest payments on the inherited stock of debt (Ц). Source Letting ф be the fraction of /-type agents in each generation, the non-social security part of the government’s budget constraint evolves according to
The exclusion of social security taxes in equation (4) reflects the fact that social security currently uses self-financing earmarked taxes.
The screening of projects in the government agencies will also tend to create a selection bias in the estimated impact. More precisely, if there is a positive correlation between a firm hitting particularly promising projects that tend to generate above average performance growth in subsequent years, and the chance of the firm receiving R&D support, the ‘difference-in-differences’ estimator will overestimate the impact of the R&D-support on the performance of the supported firms. Previous studies of the effectiveness of R&D subsidies in stimulating private R&D spending has been criticized by Kauko (1996) along these lines.
The econometric literature has suggested that such biases can be reduced or eliminated by augmenting the ‘difference-in-differences’ estimator, incorporating conditioning variables reflecting the pre-program performance27. That is, differences in longitudinal changes in performance between supported and non-supported firms should control for pre-program, temporary shocks that influence the probability of being supported, e.g. pre-program changes in R&D or firm growth. Similarly, one would also like to control for anticipated future temporary shocks that influence the probability of being supported by conditioning on forward looking variables, in particular physical and R&D investment and perhaps also hiring or firing.
An individual’s earnings ability is an exogenous function of her age, her type, and the level of labor-augmenting technical progress, which grows at a constant rate A. We concentrate all skill differences by age and type in an efficiency parameter б/. Thus, the wage rate for an agent of type j and age s is wj = ej w0 where wt is the growth-adjusted real wage at time t. ej increases with age to reflect not only the accumulation of human capital, but also technical progress.
To permit balanced growth for our specifications of preferences given the restriction on leisure shown in equation (2), we assume that technical progress also causes the time endowment of each successive generation to grow at rate A3 Thus, if EJ is the endowment of type j at age s and time t, then EJ = (1+A) ESJ, for all s, t, and j. Notice that the endowment depends only on an agent’s year of birth. Because E grows at rate A from one cohort to the next, there will be no underlying trend in wt. The growth-adjusted earnings ability profiles take the form
The model’s cohorts are distinguished by their dates of birth and their lifetime labor-productivity endowments. Following Fullerton and Rogers (1993), each cohort includes 12 lifetime-eamings groups.2 Each of these 12 groups has its own initial endowment of human capital and its own pattern of growth in this endowment over its lifetime. The lifetime-eamings groups also differ with respect to their bequest preferences. All agents live for 55 periods with certainty (corresponding to adult ages 21 through 75), and eachy-type generation is 1 +и times larger than its predecessor. At model age 21, each /-type cohort gives birth to a cohort of the same type. Population growth is exogenous, and each cohort is (1+w)20 larger than its parent cohort.
Preferences and Household Budget Constraints
Each у-type agent who begins her economic life at date t chooses perfect-foresight consumption paths (c), leisure paths (/), and intergenerational transfers (b) to maximize a time-separable utility function of the form
In (1) a is the utility weight on leisure, у is the intertemporal elasticity of substitution in the leisure/consumption composite, and p is the intratemporal elasticity of substitution between consumption and leisure. The parameter ^ is a /-type specific utility weight placed on bequests left to each child when the agent dies. The term P = l/(l+6) where 6 is the rate of time preference, assumed to be the same for all agents.
An obvious extension to the model that would produce results intermediate to those arising under either extreme assumption is to add one or more countries to the model. Indeed, adding a large number of countries would permit the consideration of trade policy as well as monetary and fiscal policy integration.
Adding Idiosyncratic Uncertainty
A final area for future work is adding idiosyncratic uncertainty to the model along the lines of Huang, et. al. (1997). Three types of uncertainty immediately come to mind — wage rate uncertainty, lifespan uncertainty, and workspan uncertainty. The introduction of dynamic programming to the model is, of course, critically important for addressing these issues. By making uncertainty idiosyncratic, one avoids aggregate uncertainty which would dramatically increase the dimension of the computational problem comments.
Using dynamic programming to solve for the model’s micro behavior will also permit us to incorporate liquidity constraints in agents’ decision making. Liquidity constraints refer to limitations on agents’ ability to borrow. Liquidity constraints play an important role in considering certain Social Security privatization proposals. Take proposals that pay off the unfunded liability of the current system by levying a consumption tax. Such proposals would seem to benefit workers because they entail the elimination of the payroll tax and the substitution of a consumption tax that retirees would pay as well as workers.
But such proposals also entail compulsory contributions by workers to private saving accounts. Those workers who are liquidity constrained will find that even though they’ve effectively received a tax break, the requirement of contributing to a new saving account means, in light of their inability to borrow, being forced to lower their current consumption. Whether such workers would actually end up, on balance, worse off is one of the research questions to be addressed in this project. It’s possible that, in terms of their remaining lifetime utility levels, their reduced consumption in the short run would be more than offset by higher consumption in the long run.
In the course of adding demographics we’ll also be able to incorporate immigration into the model. Immigration will be treated as exogenous. The model will be set up so that users can input the number and age structure of immigrations in current and future years. In setting up the model in this manner, we’ll be able to consider the potential for immigration policy to improve or exacerbate Social Security’s long-term financial condition comments.
Permitting the Model to Start from an Arbitrary Set of Economic Conditions In addition to incorporating demographics, a key improvement to the model now underway is permitting it to begin a simulation from an arbitrary set of economic circumstances. At the moment the model solves for an initial steady state and starts policy-reform simulations from that steady state. This is unsatisfactory because there is no reason to think the U.S. economy is currently in a steady state, either with respect to its demographics or its economic fundamentals.