Reserve Bank of Australia

An Integrated Microsimulation and Applied General Equilibrium Approach to Modelling Fiscal Reform

Email address: PlumbM@rba.gov.au

Keywords: Microsimulation, Applied general equilibrium, Corporate tax incidence

JEL Classifications: D31, D33, D58, H22, H30

Abstract:
In recent times there has been an increase in both the number and scope of empirical methods for providing economic assessments of tax and welfare reform. This paper develops a framework for analysing fiscal reforms that overcomes some of the significant conceptual and methodological deficiencies of existing approaches. The IMAGE (Integrated Microsimulation and Applied General Equilibrium) model developed for the UK is documented, and employed to analyse the important issue of corporate tax reform. The IMAGE model is the first to integrate the detailed demand-based approach typical of microsimulation models with the market analysis of applied general equilibrium models. In this respect, the model can simulate the impact of a given tax reform on the personal distribution of income, the functional distribution of income, economic efficiency and government revenue. In addition, the model incorporates imperfect competition in production. These features of the model are central to the main application in the paper, namely the examination of the incidence of corporate taxation. For example, the incorporation of micro-unit household data enables the effects of corporation tax reform on the household distribution of income to be examined in detail, which has not been possible with existing empirical tax models. Model simulation results are presented for a general reduction in corporation tax rates, financed by lump-sum taxation. The model indicates a simulated efficiency gain from the reform, but entails substantial redistribution towards wealthier households and a significant increase in inequality. With respect to the functional distribution of income, the reform redistributes income from labour to owners of capital. The results are placed in the context of existing studies of the incidence of corporate taxation, and demonstrate how the methodological extensions implemented in the empirical model have a significant impact on corporate tax incidence. The paper goes further by applying recently developed techniques to compute measures of statistical reliability for simulation results, an area that has received insufficient attention in the empirical tax modelling literature.

PDF file of paper: plumb.pdf

Session: Income Distributions and Inequality

Time: Friday, 6 July, 8:45am - 10:15am

Room: E