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1 Michael Schuyler, The Taxes and Growth Model - A Brief Overview 1 (2014)

handle is hein.taxfoundation/taxfaai0001 and id is 1 raw text is: TAX( FOUNDATION The Taxes and Growth Model- A Brief Overview May. 2014 . No. 429 By Michael Schuyler Fe ow The Tax Foundation's Taxes and Growth (TAG) model has two main, interactive components. The first part, known as a production function, relates inputs of labor and capital to the economy's output. The particular type of production function chosen, Cobb-Douglas, has historically provided a good fit for U.S. economic data. The quantities of labor and capital that people wish to supply in an economy depend on incentives, and some of those incentives are tax related. If tax changes reduce after-tax rewards for working or investing, people will be less eager to work or invest. Conversely, they will wish to work and invest more if tax changes increase after-tax rewards by taking a smaller bite at the margin out of the returns on productive efforts. The production function computes how the tax-induced changes in labor and capital inputs will affect economic output. Empirically, the supply of labor responds modestly to changes in after-tax rewards, while people's willingness to save and invest is extremely sensitive to expected after-tax rewards. This means that while higher marginal tax rates on labor cause people to work less, taxes that increase the cost of capital, such as dividend and capital gains taxes, slower cost recovery schedules, and the corporate income tax, elicit much greater negative responses. The second part of the TAG model is an individual income tax calculator. Using a sample of approximately 140,000 anonymous tax records from the Internal Revenue Service (the 2008 Public Use File), the model calculates people's marginal and average income tax rates and their tax liabilities. For proposed income tax changes, the model computes the effects on how much is taxable, income tax rates, and the resulting tax liabilities. If marginal tax rates or depreciation schedules change, that will lead to adjustments in the supplies of labor and capital, which will produce changes in employment, investment, productivity, output, and growth. These real economic changes will then feed back on the income tax, because the size and health of the economy have a strong impact on income tax collections. Because capital formation reacts so strongly to after-tax rewards, a tax change that is primarily assessed on returns to capital will generate an especially large positive or negative growth effect. 1 Visit http://taxfoundation.org/tax-topics/federal-taxes for links to more information about the Tax Foundation's Taxes and Growth (TAG) model.