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DAGEM - A Dynamic Applied General Equilibrium Model for Tax Policy Evaluation
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This paper develops - a sequential dynamic general equilibrium model of the U.S. economy - DAGEM. Economic behavior of every agent in this economy is derived from an intertemporal specification of the agent's objectives and constraints. Firms maximize the present value of the net cash flow in a technology with adjustment costs to determine endogenously optimal supplies and optimal demands for the different production inputs. In particular, investment decisions are forward looking. Real investment is financed by retained earnings and issuance of new debt and equity according to exogenously defined rules. Government intertemporal behavior is obtained from the maximization of a social welfare function defined over the domain of a public good and subject to an intertemporal budget constraint. The government is allowed to run deficits which are financed by issuing bonds. Optimal household behavior follows a life-cycle type of model generating endogenous savings and labor-leisure decisions. Household asset portfolio decisions merely accommodate the composition of demand for funds. Equilibrium in this economy is conceived as a temporary Walrasian equilibrium. All the markets clear, hence the Walrasian nature of equilibrium. Also, equilibrium in the short run is such that market clearing prices are parametric on the expectation formation rules, hence the temporary nature of equilibrium. The second part of this paper addresses problems of implementation and policy analysis with the DAGEM. In the context of applied general equilibrium analysis, policy evaluations are typically carried out by contrasting a base case reflecting the status quo and several counterfactual equilibria reflecting different scenarios generated by the policy change under consideration. First, it is necessary to specify the base case equilibrium. In particular, the data requirements are reviewed and sources provided. Secondly, the different equilibria are made comparable by the use of the concept of equal yield. The concept of equal yield is generalized to accommodate the existence of government deficits. Thirdly, the information contained in the different equiljbria is synthesized by using a scalar indicator. This indicator is the dynamic generalization of the Hicksian compensation tests to a context in Which expectations are not self-fulfilling, and no future markets exist. This chapter contains also a discussion of the computation strategy and, in particular, the computation algorithm. This paper concludes with a critical assessment of the DAGEM in terms of modeling and implementation as well as suggestions for future research. The potential of the methodology developed in this paper is emphasized. In particular, the merits of DAGEM to address several public finance issues, like the possible re-introduction of investment tax credits or the effects of political measures tending to balance the government budget, are discussed.
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Marvão Pereira, Alfredo, DAGEM - A Dynamic Applied General Equilibrium Model for Tax Policy Evaluation (April, 1988). FEUNL Working Paper Series No. 85