Association for Public Policy Analysis & Management

Panel: Using Microsimulation Models to Evaluate Tax Policies That Affect Low-Income Families with Children

(Poverty and Income Policy)

Tax programs provide critical benefits to low- and moderate-income families with children. This panel examines several main types:   refundable tax credits which pay money to filers, non-refundable tax credits which can offset taxes owed, and deductions and exemptionswhich reduce the amount of income that is taxed. Microsimulation models can answer questions about how many families would be affected by proposed tax policies, the average amount of the benefit, and differential impacts across demographic subgroups. This panel will (1) shed light on microsimulation as an effective evaluation tool for analyzing tax policies and their interactions with transfers, using an example focused on child care expenses; (2) describe the child tax credit and how reforms could alter who benefits from the credit; and (3) identify marginal tax “cliffs,” that is, points when increased earnings translate into little or no net income gain as transfer benefits phase out, and identify the largest program contributors to these cliffs.

The tax system affects almost all families in the United States, and reforming the system can affect many families’ real take-home income. Fortunately, the magnitude of impacts are knowable via microsimulation prior to policy implementation.  These models are essential tools for evaluating tax policy and allow researchers and policy makers to answer questions such as: How many families will be affected by a policy change? What is the size of the effect, that is, how much more or less will families pay or receive in taxes? And how do the answers to these questions differ across income bands?

The first paper lays out what microsimulation models are, what they can do, and demonstrates the value of microsimulation as an evaluation tool. For illustration, its presents tax policy options aimed at reducing the burden of child care expenses for parents. The second paper focuses on the child tax credit and provides analyses of policy options to better target needy families while considering costs to government. The third paper examines marginal tax rates faced by poor and low-income families when small increases in earned income cause families to lose eligibility for valuable benefits, thus creating marginal tax “cliffs" (i.e., where each additional dollar of earned income increases net income by zero, or worse). This paper also examines strategies for using the EITC to “smooth” such income cliffs so that it always “pays” to work more or earn more.