Key Points
Expanding federal debt presents an opportunity to rethink U.S. federal fiscal policy while growing the economy and enhancing social insurance. We present illustrative fundamental reforms of federal tax and spending programs consistent with standard design principles that have emerged over time in the field of public economics.
Specifically, we analyze 13 major tax and spending reforms that include a full accounting of their budgetary and economic interactions, arguably one of the most ambitious computational public finance experiments performed to date.
Over the next 30 years, relative to current law, these reforms: (i) reduce federal budget deficits by 38 percent; (ii) grow the capital stock by 31 percent, GDP by 21 percent, and wages by almost 7 percent; (iii) reduce health insurance premiums by 27 percent; (iv) produce almost universal health insurance enrollment along with improvements in average health and productivity; (v) reduce old-age poverty; and (vi) reduce carbon emissions, relative to current law. These changes improve the welfare of many current and all future generations, especially future lower-income households who gain the equivalent of $300,000 in lifetime value from the reforms.
Principles-Based Illustrative Reforms of Federal Tax and Spending Programs
In April 2024, we analyzed three illustrative policy bundles that reduced U.S. federal debt relative to current law while increasing economic growth over the long term. Each bundle reflected conversations with experts across the political spectrum with minimal adjustments by us.
In this brief, we analyze an additional policy bundle that includes thirteen major policy proposals chosen independently of any political point of view. Instead, we start with policy design principles that have become generally accepted in the field of public economics over the past several decades. These policy design principles include:
Government spending focused on the provision of public goods, addressing market failures, and risk pooling.
The use of corrective taxes to internalize externalities.
Tax simplification broadens tax bases with lower rates to reduce economic distortions.
Progressive taxation implemented with the lowest possible rates to raise necessary revenue while minimizing inefficiencies.
Mandatory savings for a portion of future health care expenses to reduce moral hazard (“the Samaritan’s Dilemma”).
Consideration of the full incidence of taxes and spending in general equilibrium, recognizing that the true economic burden is independent of the entity legally responsible for paying the tax.
Relative to our previous analyses, the extra degree of freedom to illustrate a plan design without political consideration affords much larger reductions in debt while increasing economic growth and enhancing social insurance. The long-run increases in investment capital (31 percent larger), hours worked (13.5 percent larger), and wages (6.8 percent larger) are bigger than any set of reforms previously analyzed by PWBM.
As with all our analyses, PWBM does not recommend or advocate for the illustrative policy reforms analyzed herein. Instead, our main goal is both theoretical and practical. A common misunderstanding is that serious debt reduction must come at the expense of economic growth or the social safety net. We show that this is incorrect. The reforms herein produce sustained debt reduction, grow the economy, reduce carbon emissions, almost fully close current gaps in working-age health-care coverage, and reduce poverty among retirees.
The policy bundle consists of four broad categories: simplifying the tax code, reducing tax-induced distortions, implementing corrective taxes to address negative externalities, and reinforcing the long-term solvency of Social Security and Medicare while fostering economic growth.
- Simplifying the tax code: These policy changes aim to simplify the tax code and remove incentives to reclassify labor income to receive favorable tax treatment. Policies included in this category are:
- Tax capital gains and dividends at ordinary rates; tax capital gains at death without stepped-up basis: Under current law, we have a progressive rate structure that taxes ordinary income at the following marginal rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. For single filers in 2024, each of these marginal rates apply to income above each the following thresholds, respectively (married filer thresholds in parentheses): $0 ($0), $11,600 ($23,200), $47,150 ($94,300), $100,525 ($201,050), $191,950 ($383,900), $243,725 ($487,450) and $609,350 ($731,200). All these thresholds are adjusted annually for inflation. Ordinary income includes wages, salaries, tips, commissions, interest, dividends (in some cases), rental income, and business income. However, some types of income are taxed at rates lower than these ordinary rates. That income, generally capital gains held for a minimum period and qualifying dividends, is known as preferred income and is taxed at preferential tax rates of 0%, 15%, and 20%. Those rates apply to preferred income for taxable income above the following thresholds for single filers in 2024 (married in parentheses): $0 ($0), $47,025 ($94,050), $518,900 ($583,750). All these thresholds are adjusted annually for inflation. That preferred rate structure means that someone in a high ordinary tax bracket can potentially pay a lower marginal tax rate on income from long-term capital gains and certain dividends. Moreover, the basis of unrealized capital gains is stepped-up when assets are transferred at the time of death, meaning that capital gains are set to zero. This policy change would remove that preferential rate structure and the distinction between preferred and ordinary income, taxing all income from capital gains and dividends using the ordinary income tax rate structure, including rates and thresholds. It would also subject capital gains without stepped-up basis to those rates at the time of the holder’s death. This policy would take effect in 2025.
- Expand the base of employment taxes to cover all pass-through income: Under current law, workers with wage earnings from businesses owned by others pay payroll taxes through the Federal Insurance Contributions Act (FICA) tax. In contrast, individuals with earnings from businesses they own, but that are not incorporated, pay payroll taxes on only a portion of their income through the Self-Employment Contributions Act (SECA). For both types of income, the total payroll tax rate is 15.3% on individual employment income up to $160,200 in 2024, with this threshold adjusted annually for inflation. Under FICA, this tax is evenly split between the employer and employee, while under SECA, the individual pays the entire 15.3%, as they are considered both employer and employee. Above this threshold, the total payroll tax rate drops to 2.9%, with an additional 0.9% Medicare surtax applied to income exceeding $200,000 for single filers and $250,000 for married filers. Under current law, non-wage income from limited partnerships and S corporations is not subject to payroll taxes. However, starting in 2025, this policy would expand the self-employment payroll tax base to include all pass-through income, regardless of the business's organizational structure.
- Disallow all itemized deductions except for charitable deductions: Under current law, when individuals calculate their income tax liability, they can elect to take either the standard deduction ($29,200 in 2024 for married filers, $14,600 for singles, annually adjusted for inflation) or a set of itemized deductions, which includes deductions for mortgage interest, state and local taxes, charitable contributions, some unreimbursed medical expenses, some long term care premiums, some losses from casualty and theft, and a host of miscellaneous deductions. These deductions are used to reduce taxable income and, therefore, the final tax liability for those who take them. For some taxpayers, and especially high-income taxpayers, the value of these itemized deductions can greatly exceed the standard deduction. Starting in 2025, this policy change would disallow all itemized deductions except for charitable contributions.
- Remove the income exclusion of employer-sponsored health insurance premiums and introduce mandatory Health Savings Accounts: Under current law, individuals who are offered health insurance through their employer can exclude the full amount of their health insurance premiums from their taxable income. This policy would eliminate that exclusion, requiring individuals to include the value of employer-sponsored health insurance in their taxable income. This policy change also requires all individuals to establish a Health Savings Account (HSA) that can cover up to $3,000 per year in out-of-pocket healthcare expenses. This account is available to all individuals, whether they purchase health insurance or not. Uninsured individuals with out-of-pocket spending exceeding their HSA amount qualify for Medicaid if their income and assets are low enough.
- Reducing tax distortions: Under current law, effective marginal tax rates and the final tax liability exhibit large changes with sometimes minor changes in earnings, thereby distorting household decisions to work. These policy changes flatten the marginal tax rate schedule and reduce those distortions:
- Replace the standard deduction and personal exemptions with a partially refundable credit: Under current law, filers who do not itemize take a standard deduction of $29,200 in 2024 for married filers ($14,600 for singles). After the Tax Cuts and Jobs Act expires at the end of 2025, the value of the standard deduction will be reduced to about $16,000 for married filers (about $8,000 for singles), and all filers will be able to take an additional personal exemption (about $5,000) for themselves and their dependents. These values are adjusted annually for inflation. These deductions and exemptions are used to reduce taxable income when calculating tax liability, ultimately reducing total liability and in some cases dropping individuals into lower marginal rate brackets. This policy repeals both the standard deduction and the personal exemption and replaces them with a new refundable tax credit beginning in 2025. This credit would be worth a maximum of $3,000 per qualifying household member. The credit would be partially refundable: half the credit ($1,500 per household member in 2025) would be available to all regardless of earnings, and the remainder would phase in at a rate of 50% of earned income. All values would be adjusted annually for inflation. For example, a single filer with $2,000 in wage earnings would receive a refundable credit value of $2,500 in 2025, reflecting the base value of $1,500 plus $1,000 (0.5 * $2,000 in wage earnings). A filer with 2 minor children and $6,000 of wage income would receive a refundable credit of $7,500, reflecting the base value of $4,500 ($1,500 per person) plus $3,000 (0.5 * $6,000 in wage earnings). If that filer with 2 minor children instead had $10,000 of wage earnings, they would receive the maximum $9,000 credit for their household size ($3,000 per person) as their earned income would be sufficient to receive the fully phased-in value of the credit. A filer’s credit would reduce their final tax liability on a dollar-for-dollar basis, with any remaining credit value being refundable upon filing. This differs from the standard deduction and personal exemptions under current law, which reduce taxable income rather than directly lowering final liability. The standard deduction and exemptions do not provide a refundable credit to filers with low tax liability.
- Reduce the top ordinary income tax rate to 28%: Under current law, we have a progressive rate structure that taxes ordinary income at the following marginal rates: 10%, 12%, 22%, 24%, 32%, 35%, and 37%. For single filers in 2024, each of these marginal rates apply to income above each the following thresholds, respectively (married filer thresholds in parentheses): $0 ($0), $11,600 ($23,200), $47,150 ($94,300), $100,525 ($201,050), $191,950 ($383,900), $243,725 ($487,450) and $609,350 ($731,200). Under this policy, in 2025 the above marginal rate structure would be replaced by the following: 10%, 12%, 22%, 24%, 28%, for the following income thresholds in 2024 dollars respectively: $0 ($0), $11,600 ($23,200), $47,150 ($94,300), $100,525 ($201,050), and $191,950 ($383,900). All thresholds would continue to be adjusted annually for inflation. In short, this would replace the current 32% marginal rate bracket with a 28% marginal rate bracket at the same threshold and remove the higher marginal rate brackets entirely (35% and 37%). When the TCJA expires in at the end of 2025, the marginal rates and brackets below the 28% rate revert to their pre-TCJA state, but the top marginal rate of 28% would stay in place with no higher rates above it, for the following marginal rate structure 10%, 15%, 25%, 28%, applied to income above the following approximate thresholds in 2026 dollars: $0 ($0), $11,800 ($23,600), $48,100 ($80,300), $116,400 ($193,900). These values would continue to be adjusted annually for inflation.
- Corrective taxes to price negative externalities: Carbon emissions are a major driver of global warming. To move away from a carbon-based economy and encourage greater investment in renewable energy sources, this policy change would tax carbon emissions to reduce carbon emissions efficiently.
- Implement a carbon tax: Under current law, the U.S. does not impose a carbon tax. This policy change would introduce a tax on coal, oil products, and natural gas based on their carbon content, which would be collected from fuel suppliers. The policy would levy a tax of $50 per ton of carbon emitted. Although smaller than the “optimal level” reported in many studies (which suggest a tax closer to $150 to $200 per ton), this tax aims to reduce greenhouse gas emissions by 7 percent in the short run and by approximately 16 percent by 2054. This policy is set to take effect in 2025.
- Improving the long-term solvency of Social Security and Medicare while promoting growth: As the U.S. population ages and retirees live longer, fewer working-age families support more and more retirees through their payroll taxes to finance Social Security and Medicare. The United States cannot grow its way out of the shortfalls facing these two major mandatory spending programs: the spending in both programs is either explicitly or implicitly indexed for growth. Both programs materially reduce the accumulation of savings and reduce the incentive to work, which reduces growth. The following policy changes ensure retirees are kept out of poverty, both Social Security and Medicare remain financially solvent, and the disincentives to save and work are reduced:
- Raise the full-benefit Social Security retirement age from 67 to 70, phased in between 2037 and 2056: Under current law, the Normal Retirement Age (“NRA”) for Social Security---the age at which beneficiaries can claim their full benefits based on career-average monthly earnings---is 67 for individuals born in 1960 or later (those who are 65 and younger in 2025). This policy change would gradually continue to increase the NRA by two months per year until it reaches 70. The policy change would not affect individuals older than 50 in 2025 (those born between 1960 and 1974). The first group impacted by this policy change are individuals born in 1975, while cohorts who face an NRA of 70 are those born after 1991.
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Flatten Social Security benefits over time, phased in between 2037 and 2056: This policy change would establish both a new minimum and maximum Social Security benefit. The minimum benefit would ensure that retirees remain above the federal poverty line, reducing the retiree poverty rate from 11.3% in 2023 to zero. Meanwhile, the new maximum benefit, significantly lower than under current law, would help secure Social Security’s long-term solvency. By flattening benefits across income levels, this policy would largely decouple Social Security payments from individual earnings history.1 For those born in 1994 or later, Social Security would shift from a traditional pension model to a retiree poverty-relief program, with additional retirement consumption relying on private savings.
Social Security benefits are calculated by taking a beneficiary’s lifetime average monthly earnings (AIME) and applying a set of fixed percentages to each earnings segment. Under current law, those percentages are 90, 32, and 15 percent in 2024, and they are applied to the following segments of AIME: below $1,175 (90 percent), between $1,175 and $7,708 (32 percent), and above $7,708 (15 percent).
- A new minimum benefit. A new minimum benefit would be introduced and fully implemented in 2037, equaling the federal poverty line. The minimum benefit increases benefits for retirees who are 50 and younger in 2025 (those born after 1974), who have had low income throughout their working years.
- A new maximum benefit. A new maximum benefit would be phased in over time: the set of fixed percentages that apply to each segment of lifetime earnings would gradually decrease over a 20-year period to values of 90 percent, 4 percent, and 0 percent. While the minimum benefit is fully implemented in 2037, only the first year of this 20-year transition period starts in 2037. Thus, it only applies to individuals 50 years and younger in 2025 (those born after 1974). Specifically, individuals born after 1975 can claim early benefits at age 62 (in 2037) in exchange for a benefit reduction or full benefits at the NRA (in 2042). However, their maximum benefit would be reduced by around 1/20th of the full reduction in the maximum benefit noted above. The new maximum benefit would be fully phased in by 2056, that is, for individuals aged 30 or younger in 2025 (born after 1995).
- Raise the Medicare eligibility age from 65 to 67, fully phased in by 2036: Under current law, most people qualify for Medicare coverage upon reaching age 65 and some individuals become eligible earlier if they have certain medical conditions. This policy change would increase the eligibility age by two months every calendar year to a maximum age of 67, while leaving unchanged the separate qualifying parameters for individuals with certain disabilities. This policy starts in 2025, with an eligibility age of 65 plus two months, so that people retiring in 2036 would be the first cohort to face the eligibility age of 67.
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Convert Medicare to premium support: This policy would transition Medicare to a premium support system, allowing beneficiaries to choose from competing insurance plans, with the federal government sharing the cost of premiums. While previous proposals have varied, particularly regarding how the federal contribution is determined, the policy modeled here would involve private health insurers submitting bids to provide Medicare Part B services. The average bid, including that from the traditional Medicare fee-for-service program, would serve as the benchmark for calculating Medicare’s contribution to premiums.
Under this system, the federal government would pay insurers the benchmark rate minus the standard premium paid by enrollees. Beneficiaries choosing a plan with a bid matching the benchmark would pay a standard premium directly to the insurer, covering roughly 25 percent of total Medicare Part B costs. If a beneficiary selects a plan with a bid above the benchmark, they will pay the standard premium plus the difference between the bid and the benchmark. Conversely, if the plan's bid is below the benchmark, the beneficiary would pay the standard premium minus the difference. This policy is set to take effect in 2025.
- Broad-based immigration reform, with new immigrants required to purchase health insurance without government subsidy: Under current law, approximately 1.3 million foreign individuals are permitted to immigrate to the United States annually, either permanently or on temporary work visas. Without immigration, the U.S. population is projected to decline over time. Even with current immigration levels, the Penn Wharton Budget Model (PWBM) estimates that the ratio of workers to retirees will fall from 3.0 workers per retiree today to just 2.0 workers per retiree in 50 years. This new immigration policy would double the number of legal immigrants allowed each year and require all immigrants to obtain health insurance that is neither subsidized nor funded by the federal government. This restriction would include exclusions from programs like Medicaid and premium subsidies under the Affordable Care Act (ACA). The policy is set to take effect in 2025.
If enacted in 2025, Table 1 shows that these reforms would generate net revenues (deficit reduction) of $10.0 trillion over the 10-year budget window and $59.0 trillion over the 2025-2054 period on a conventional basis, that is, before dynamic feedback effects. The largest revenue raiser over the 2025-2054 period is comprehensive immigration reform, which doubles the number of legal immigrants who would be subject to taxation but do not qualify for government programs other than OASI based on their lifetime contributions. In addition, immigrants would need to purchase private health insurance and would not be eligible for Medicare, Medicaid, or ACA premium subsidies.
The next largest revenue raiser is removing the exclusion of employer-sponsored health insurance (ESI) premiums. Under this policy, households would establish Health Savings Accounts (HSAs) allowing them to deduct up to $3,000 of out-of-pocket spending from their taxable income. Together, these two policies would increase revenues by $13.3 trillion over the 2025-2034 period and by $66.0 trillion over the next 30 years.
The two policies that would result in revenue losses over the next 30 years, on a conventional basis, are the replacement of standard deductions and personal exemptions with a partially refundable credit, and the reduction of the top income tax rate to 28 percent. Combined, these policies are expected to reduce revenues by $5.9 trillion over the next 10 years and by $23.2 trillion over the 2025-2054 period.
| Policy | 2025 | 2026 | 2027 | 2028 | 2029 | 2030 | 2031 | 2032 | 2033 | 2034 | 2025-2034 | 2025-2054 |
|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Tax capital gains and dividends at ordinary rates | 37 | 60 | 40 | 39 | 41 | 42 | 44 | 45 | 47 | 48 | 444 | 1,800 |
| Expand the base of employment taxes to cover all pass-through income | 49 | 66 | 68 | 70 | 73 | 76 | 79 | 82 | 85 | 88 | 736 | 3,293 |
| Disallow all itemized deductions except charitable deduction | 18 | 127 | 254 | 264 | 276 | 288 | 301 | 314 | 327 | 339 | 2,507 | 12,785 |
| Replace standard deductions and personal exemptions with a partially refundable credit | 40 | -558 | -480 | -488 | -494 | -503 | -510 | -516 | -521 | -529 | -4,559 | -17,102 |
| Reduce the top ordinary income tax rate to 28 percent | -111 | -167 | -113 | -119 | -123 | -130 | -135 | -142 | -146 | -152 | -1,337 | -6,079 |
| Implement a carbon tax | 85 | 80 | 77 | 74 | 71 | 73 | 77 | 81 | 83 | 86 | 787 | 3,252 |
| Raise the full-benefit Social Security retirement age from 67 to 70, phased in between 2037 and 2056 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 1,522 |
| Flatten Social Security benefits, phased in between 2037 and 2056. | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 0 | 2,368 |
| Raise the Medicare eligibility age from 65 to 67, fully phased in by 2036. | 0 | 0 | 13 | 14 | 15 | 16 | 18 | 19 | 19 | 20 | 135 | 1,702 |
| Convert Medicare to premium support | 80 | 85 | 91 | 96 | 102 | 108 | 115 | 121 | 127 | 134 | 1,059 | 5,286 |
| Remove exclusion of ESI premiums and introduce mandatory Health Savings Accounts | 437 | 499 | 511 | 526 | 540 | 556 | 572 | 590 | 610 | 631 | 5,472 | 22,860 |
| Broad-based immigration reform | 515 | 636 | 677 | 721 | 763 | 801 | 844 | 890 | 939 | 996 | 7,781 | 43,159 |
| Interaction effects | -66 | -256 | -251 | -270 | -298 | -316 | -340 | -362 | -396 | -423 | -2,978 | -15,872 |
| Effect on primary deficit (-) or surplus (+) | 1,083 | 572 | 887 | 928 | 965 | 1,013 | 1,065 | 1,122 | 1,173 | 1,238 | 10,046 | 58,974 |
Table 2 shows that the set of policy changes would grow GDP by 21 percent by 2054 compared to current law. This growth is driven by a 31 percent expansion in the capital stock and a 14 percent rise in total hours worked. Additional immigration increases the U.S. population size by 12 percent by 2054 (see Table 3), helping to expand the labor force. Immigrants contribute not only to total hours worked but also to capital formation through savings, which helps fuel capital stock growth. Still, output per capita increases by 8 percent in 2054, reflecting gains in capital accumulation that extend beyond the contributions of increased immigration.
Another important factor driving capital growth is the policy bundle’s effect on federal debt, which declines by 38 percent by 2054. Reduced federal debt allows households to allocate more of their savings toward productive capital rather than government bonds, thereby further expanding the capital stock. Consequently, wages increase by 7 percent, and consumption rises by 10 percent in 2054.
| 2034 | 2039 | 2044 | 2049 | 2054 | |
|---|---|---|---|---|---|
| Gross domestic product | 4.8 | 8.1 | 11.6 | 15.9 | 21.1 |
| Capital stock | 4.8 | 9.2 | 14.8 | 22.0 | 31.3 |
| Hours worked | 5.0 | 7.3 | 9.1 | 11.2 | 13.5 |
| Average wage | 0.0 | 0.9 | 2.4 | 4.3 | 6.8 |
| Average consumption | -0.9 | 1.1 | 3.2 | 6.0 | 9.8 |
| Debt held by the public | -16.7 | -23.4 | -28.8 | -33.6 | -37.8 |
| Memorandum: | |||||
| Output per capita | 1.5 | 2.7 | 4.3 | 6.2 | 8.3 |
Table 3 shows that the policy bundle’s immigration reform materially impacts the healthcare sector. Private health insurance premiums fall over time relative to current law, by 27 percent over 30 years. This outcome is driven by two main factors. First, the requirement that all immigrants enroll in private health insurance reduces moral hazard, which in turn lowers overall premiums and encourages increased enrollment among native-born citizens. Second, immigrants are, on average, significantly younger than the native-born population—by about 8 years. Expanding the insurance pool with younger, healthier individuals further reduces healthcare premiums and boosts native enrollment, achieving near-universal health insurance coverage.
The fall in premiums leads to higher insurance enrollment, despite no requirement to purchase insurance to cover losses above the $3,000 Health Savings Accounts. In fact, under current policy, we project that the uninsured population will rise from about 14 percent today to about 19 percent by 2034 and continue to 27 percent by 2054. The policy reforms herein not only prevent that increase but also drive uninsured rates to near zero.
Healthcare spending shifts from the government to the private sector. Spending on Medicaid falls by 41 percent over 30 years. Spending on Medicare falls by 11 percent due to moving to a premium support model, changes in the claiming age, and improvements in general health and well-being by retirees who are now more likely to be insured prior to retirement.
| 2034 | 2039 | 2044 | 2049 | 2054 | |
|---|---|---|---|---|---|
| Percent Change from Current Law | |||||
| Population | 3 | 5 | 7 | 9 | 12 |
| Health insurance premiums | -12 | -15 | -18 | -21 | -27 |
| Private health insurance spending/insured | -4 | -6 | -8 | -10 | -12 |
| Insured payments | |||||
| Private Insurance | 4 | 16 | 29 | 30 | 28 |
| Medicaid | -23 | -27 | -26 | -27 | -31 |
| Medicare | -3 | -11 | -10 | -14 | -14 |
| Percent Levels | |||||
| Current law | |||||
| Private Insurance, working age | 68 | 66 | 65 | 62 | 57 |
| Uninsured, working age | 26 | 27 | 28 | 31 | 38 |
| Uninsured, total population | 19 | 19 | 20 | 22 | 27 |
| Policy | |||||
| Private Insurance, working age | 91 | 93 | 93 | 93 | 93 |
| Uninsured, working age | 0.5 | 0.5 | 0.4 | 0.4 | 0.4 |
| Uninsured, total population | 0.3 | 0.3 | 0.3 | 0.3 | 0.3 |
Conventional distributional analysis reports how household post-fisc income changes due to changes in taxes less transfers or benefits received. This information is represented as a cross-section of the population for a given year. Conventional analysis often focuses on tax provisions alone, maybe net of various provisions like the EITC. However, we generally include the effects of tax and spending provisions—including Medicaid, Social Security benefits, and food stamps—except for spending that is widely shared, such as roads and military, which would be too subjective in nature to differentiate by income group.
Table 4 reports the conventional analysis for this illustrative policy bundle across three different policy years: 2025, 2034, and 2054. Different years are provided because different policies may phase in over time and at different speeds. For example, most of the policies start in 2025 while some are phased in over the next 20 years. With conventional distributional analysis, the results do not reflect changes in macroeconomic variables.
As Table 4 shows, lower-income households generally gain from implementing the policy changes in this bundle, while those in the top quintile generally see their post-fisc income decrease. In fact, households in the bottom income quintile are among the biggest winners of this change, both in absolute terms and relative to their income. This is largely due to the replacement of the standard deduction and personal exemptions with a partially refundable credit. Many households in the bottom quintile have very little or no income tax liability after current law deductions and credits. For these households, the new partially refundable credit that replaces the standard deduction constitutes a large transfer as a share of income. In each of the three years shown, the post-fisc income of this quintile increases by between $3,700 and $5,000. That increase is only outdone by households in the 99-99.9 percentile, whose post-fisc income increases by between $6,440 in 2025 and $51,685 in 2054. Yet, relative to their post-fisc income, those in the first quintile experience by far the largest gains.
In 2025, the 90-99 percentiles experience the largest losses in percent of after-tax income because several of the constituent policies target deductions and tax preferences that benefit this cohort the most under current law. Eliminating all itemized deductions is more likely to affect the top end of the distribution, as they are more likely to itemize under current law.
By 2054, larger losses appear for households in the middle quantile. This seemingly counterintuitive behavior is driven by the shortcomings of conventional distributional analysis itself, which does not distinguish by age. Retirees who receive smaller Social Security benefits relative to current law tend to appear below the top percentiles in the income distribution even though the retirees previously fell inside these percentiles during their working ages when other sources of income, including wages and salary, are much larger. This dynamic plays out in a similar fashion for the changes to Medicare analyzed in this brief, which affects a similar segment of the population. Conventional distributional analysis does not classify these households based on lifetime (or “lifecycle”) incomes. Conventional distributional analysis also does not include any effects of economic growth. We address these shortcomings with dynamic distributional analysis.
| Income group | 2025 | 2034 | 2054 | |||
|---|---|---|---|---|---|---|
| Average income change, after taxes and transfers | Average percent change in income, after taxes and transfers | Average income change, after taxes and transfers | Average percent change in income, after taxes and transfers | Average income change, after taxes and transfers | Average percent change in income, after taxes and transfers | |
| First quintile | $3,760 | 237.0% | $3,980 | 273.1% | $4,925 | 196.8% |
| Second quintile | $3,680 | 12.8% | $1,395 | 3.7% | -$625 | -0.7% |
| Middle quintile | $1,880 | 3.2% | -$175 | 0.0% | -$5,425 | -3.6% |
| Fourth quintile | $255 | 0.3% | -$4,175 | -2.7% | -$11,550 | -4.5% |
| 80-90% | -$1,255 | -0.6% | -$7,750 | -3.1% | -$16,955 | -4.0% |
| 90-95% | -$2,830 | -1.0% | -$11,930 | -3.2% | -$17,845 | -2.8% |
| 95-99% | -$4,815 | -1.0% | -$8,945 | -1.5% | -$10,765 | -1.1% |
| 99-99.9% | $6,440 | 0.4% | $20,405 | 0.8% | $51,685 | 1.3% |
| Top 0.1% | -$43,365 | 0.3% | $16,480 | 1.2% | $25,810 | 1.3% |
Dynamic distributional analysis considers households across the income and age distribution, including the unborn represented by a negative age index at the time of the reform. It asks how much each household in the (income, age) combination values the proposed policy change over their entire lifetime, represented as a one-time transfer at the time of the policy change. Dynamic distributional analysis is the standard in academic research, where conventional analysis is rarely used due to several key limitations that dynamic analysis addresses.
A positive equivalent variation means that the person would be better off under the policy reform; a negative equivalent variation means that the person would be worse off under the policy reform. For example, as shown in Table 5, a person aged 60 at the time of the policy change and with a gross income in the lowest 20th percent of the income distribution receives $21,000 of value from this policy bundle. Put differently, this household is indifferent between the adoption of this policy bundle and receiving a one-time payment of $21,000 without this bundle. However, a household aged 30 in the highest 20th percentile loses the equivalent of $49,800, as shown by the negative value. This household would be exactly indifferent between this policy bundle and a one-time payment of $49,800 to avoid permanently adopting this bundle.
Most households stand to benefit from implementing this policy bundle, particularly future generations. The gains for most unborn households (those with a negative age index) are significantly larger than the losses for those currently alive. Future lower-income households gain the equivalent of $300,000 in lifetime value from the reforms. These future households benefit from higher wages and more affordable healthcare options.
Households currently in their 20s through 40s, however, would generally prefer to retain the current law. This is largely because they are affected by the phased-in Social Security reforms, and they still have much of their working life ahead, during which they would have benefited from the tax deductions associated with employer-sponsored insurance (ESI) premiums under current law. While they can anticipate lower retirement income due to Social Security changes, they will not experience the prolonged benefit of higher wages or lower healthcare costs to the same extent as households born further into the future.
PWBM will be releasing more details about our model over the next two years to make our framework more accessible to other academics, experts, and even policy advocates. This appendix contains only a very brief overview for now. Moreover, PWBM will also release additional information about how options like those analyzed herein improve health outcomes, productivity of the previously uninsured, and improvements to life expectancy.
A challenge in modeling such a wide range of reforms is capturing interaction effects, as some policies are more effective when combined while others are less effective. In most budget-related fiscal analyses, these interactions are often small and mostly captured with “stacking rules.” But in major reforms, the interaction effects are often first-order. For example, continuing to slowly increase the Social Security normal retirement age roughly in pace with longevity increases non-Social Security federal tax revenue, as people work and save more over time. An expansion in immigration, where new immigrants are required to purchase health insurance, has a first-order impact on healthcare insurance premiums for native-born workers by improving the health insurance risk pools. Increasing healthcare coverage improves health and productivity, which can offset some of its own program costs; but it also leads to people living a bit longer, which leads to higher Social Security costs, with changes in Medicare costs being a bit more nuanced. Of course, these changes also influence wages, interest rates, and relative prices, which provide additional feedback from U.S. households and international capital flows.
Properly capturing these interactions is critical: a simple sum of effects across each policy on an individual basis can lead to dramatic overestimates or underestimates of revenue, depending on whether the budget effects from conventional stacking are more or less important than economic feedback effects. A simple sum of policies will also not capture the correct net effect on incentives. Computing such a model in a consistent (general equilibrium) manner requires solving a large, high-dimensional system of equations for a fixed point both within and over time. Finding this fixed point is challenging in the presence of realistic non-stationary demographics; there is no real “steady state,” as is standard in academic models, other than for our internal testing purposes. Despite its neoclassical foundation with balanced growth per efficiency unit, growth per labor unit in our dynamic model is endogenous due to how changes in healthcare improve productivity, longevity, and, hence, total population size. The magnitude of the reforms considered herein pushes the envelope inside the field of computational public economics, requiring the use of thousands of computational nodes to solve a high-dimension fixed point across time with forward-looking markets.
Our analysis of the policy bundle starts with our microsimulation model, which is estimated across a range of datasets to represent hundreds of thousands of different types of households, differentiated across 60 demographic and economic attributes. The PWBM microsimulation model interacts with various fiscal tax and spending modules. The PWBM tax module estimates individual income taxes, payroll taxes, corporate taxes, and estate taxes. It also simulates behavioral responses to changes in tax policy, calculating conventional estimates of the budgetary effects of tax policies and effective tax rates for different demographic groups. The various conventional elasticities applied include income classification, business formation classification, income timing, and other material changes. The PWBM Social Security module estimates old age, dependent, survivor, and other auxiliary benefits as well as other rules. All major elements of benefits policy are parameterized, allowing for detailed analysis of reform proposals that highlight how structural shifts in demographic and economic forces affect Social Security’s finances.
This conventional modeling informs our core heterogeneous-agent overlapping-generations dynamic model (OLG). The OLG model allows for labor supply changes, capital intensity changes, and productivity changes in response to various tax and spending programs. For example, a reduction in carbon from a carbon tax produces some productivity gains over time, which is consistent with data-driven estimates.
Our OLG model also fully merges the private and public healthcare sectors into the rest of the economy. As such, U.S. private healthcare (employer) and public healthcare (Medicare, Affordable Care Act, Medicaid, and other programs) are modeled in detail. When making labor supply and savings decisions, households simultaneously make decisions about whether to buy health insurance, whether to pay out of pocket for a healthcare shock, and even how to alter labor supply and savings to qualify for ACA premium support or Medicaid. Employers make competitive decisions about offering compensation and tax-preferred group healthcare in the presence of competition for talent in labor markets. Workers with low enough productivity—where the cost of their healthcare coverage plus a minimum wage level of income is less than their marginal product—are not offered health coverage through their employer, consistent with current evidence. Healthcare premiums are computed in general equilibrium along with factor prices (wages and interest rates). Unlike factor prices, health prices are subject to various current-law rules regarding information restrictions and risk ratings, the net effect of which can lead to dynamic adverse selection over time and moral hazard. Investments in healthcare by the government or by an individual improve individual productivity (and wages) by health state, longevity, population size, and government revenue and spending, even in non-health programs. At the same time, non-health-related changes in wages can impact elective decisions for healthcare and alter labor and savings decisions to qualify for Medicaid.
The analysis presented, therefore, considers potentially complicated interactions of policies within the policy bundle. For example, reducing the deductibility of employer healthcare increases other after-tax compensation through competitive labor markets, which is now taxable. But it also reduces private insurance coverage with more people electing ACA or Medicaid, at a cost to the government, or going without coverage, which can reduce their productivity. At the same time, changes to Social Security and Medicare encourage more household savings and labor supply, which can materially impact non-payroll federal tax revenue and mitigate some of the reduction in healthcare coverage. A carbon tax can directly increase productivity over time while also raising immediate revenue.
In general, failing to account for interactions between fiscal policies can substantially understate or overstate the impact of a given policy change on total revenue, total costs, and the economy. Indeed, the distinct modeling of Social Security, Medicare, and the rest of the federal government without capturing interactions can lead to first-order biases.
The calculations were produced by Kody Carmody, Jon Huntley, Felipe Ruiz Mazin, Ed Murphy, and Brendan Novak under the direction of Alexander Arnon, Felix Reichling, and Kent Smetters. Sophie Shin contributed to the analysis. Felix Reichling and Kent Smetters wrote the brief with input from others. Mariko Paulson prepared the brief for the website.
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This decoupling allows for more focused spending but also disconnects the marginal linkage between wages (taxes paid) and future benefits, which means that the remaining statutory rate is fully distorting, like any other tax. In contrast, with some marginal tax-benefit linkage, as in the current system, Social Security payroll taxes are less distorting than other taxes. ↩
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