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Revenue Estimates and Distributional Analysis

The Tax Foundation is frequently asked hypothetical questions about changes in tax law. The first questions reporters, policymakers and citizens often ask about a new tax proposal focus on revenue and distribution. In other words, how much will government receipts rise or fall, and which taxpayers in particular will bear the burden or receive the benefit?

When evaluating changes to the federal individual income tax, we turn to the Tax Foundation Federal Individual Income Tax Microsimulation Model (TFFIITMM). As one might imagine with an acronym that long, this model is quite complex. What it does, however, is fairly straightforward.

The model consists of programming code that reliably mimics the filing of all individual tax returns filed each year under actual law. It predicts future revenues, assuming tax law remains stable, and it calculates how much tax is paid by each income group.

When analyzing new proposals to change the tax code, such a tool is invaluable. It can compare two scenarios: the status quo versus the new tax system that someone has proposed. The first is often called the baseline scenario, the second the policy scenario. The model calculates how much revenue the government would raise under each scenario by income cohort and compares the baseline to the policy. The aggregate comparison quantifies the revenue effect of the proposed tax law change. Changes in tax payments by income cohort give the distributional effect.

Say, for example, a congressman or presidential candidate proposed giving people the option of filing their federal individual income tax returns under the existing tax system with its myriad deductions, exemptions and credits, or under an alternative, simplified system. Under this hypothetical alternative system, filers would simply subtract from their Adjusted Gross Income a $7,500 exemption for every taxpayer or dependent listed on the return and pay a flat rate tax on the remainder.

If this policy scenario seemed worthy of analysis, Tax Foundation economists would program into the model the parameters of the proposed alternative tax system: rates, exemptions, etc., next to the programming for existing federal individual income tax law. The model could calculate how many taxpayers would gain by filing under the new system, how much less they would pay on average, and in which income groups they fell. The model would also make forecasts about how such a tax system might affect the growth of various income sources, such as wages and salaries and capital gains.