Dynamic OLG Model

While the Tax Module is capable of incorporating certain conventional behavioral responses, it does not account for macroeconomic feedback effects on its own. That is, while agents in the Tax Module are able to shift and reclassify income to pay lower tax rates, their real economic decisions—such as labor supply and savings patterns—are held fixed between policy scenarios. These decisions can have important macroeconomic and budgetary implications.

Output from the Tax Module feeds into PWBM’s dynamic OLG model, which is designed to simulate the general equilibrium effects of policy reforms. The Tax Module calculates reduced-form tax functions that describe federal tax policy under current law and policy proposals. These time-varying functions include stepwise marginal tax rate structures on labor and capital income, a detailed representation of the corporate tax system, the Social Security tax system, and even functions for national consumption and wealth taxes. The Tax Module also provides the revenue projections that determine the long-run fiscal balance of the US government, an important element for agent decision-making in the model.

To produce dynamic revenue estimates, the OLG model runs in two modes: “static”, under which economic decision-making is held constant, and “dynamic”, where agents respond to price changes in general equilibrium. We takes the percent change between these two modes for budget aggregates and applies this “delta” to the conventional revenue projections from the Tax Module. This approach allows PWBM to combine the richness of detail from PWBMsim and the Tax Module along with the structural macroeconomic feedback effects incorporated in the dynamic OLG model.