TRIM3 Logo  Steps in Simulating Tax and Transfer Programs
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Despite the great variety of tax and transfer programs, the same basic steps are involved in simulating most programs. Those steps are:

The level of complexity of each step and the specific procedures involved vary across programs. However, the conceptual issues and problems are very similar across the simulation modules.

Defining the Filing Unit

The first step in a simulation is to divide the sampled household into potential filing units. A filing unit for a government tax or transfer program is the group of persons that jointly pays the tax or applies for the benefit. The analyst designing a module must understand the actual filing unit rules and then choose how to simulate those rules. Filing unit rules may be more complex in the real world than in the simulation. Because TRIM3 simulates each program in a different module, each program can define the filing unit differently.

To understand filing units, it is helpful to understand the definitions of households and families used by the U.S. Bureau of the Census. A household simply consists of all the persons who occupy a housing unit, whether or not they are related. A family includes only related persons; there may be more than one family in a household. The family containing the household head is the householder family or primary family. A related subfamily includes a head or spouse who is related to the primary family; it consists of a married couple with or without children, or one parent with one or more never married children under age 18. An unrelated subfamily does not include the household head or any relatives of the household head.

A filing unit for a program may be as broad as the entire household, or as narrow as a single individual. Family-level filing units could be defined to include related subfamilies in the primary family, or to consider related subfamilies separately. Individuals may be included or excluded from a filing unit on the basis of age, family relationship, or other criteria.

Once a household has been divided into filing units, each filing unit is taken through the simulation steps described next.

Determining Categorical Eligibility

The second step in a simulation is to decide whether a filing unit is categorically eligible for the benefit program or categorically required to pay the tax. Many programs serve only certain categories of the population. For example, Supplemental Security Income (SSI) serves only elderly and disabled persons, and Temporary Assistance for Needy Families (TANF) serves only families with children. Two special problems may arise when simulating categorical eligibility. First, most surveys include demographic information for only one point in time. Second, some information needed to determine categorical eligibility may not be well reported.

Although some questions on a survey may use an annual reference period, household composition and characteristics are generally collected only for the point at which the survey is conducted. On March Current Population Survey (CPS) files, the members of a household and their ages and other characteristics are collected as of the March survey date. Those characteristics must be used to determine categorical eligibility for the prior calendar year. The approach taken by TRIM3 is to use the March characteristics as a "snapshot" of the population and to implicitly assume that they have been unchanged since January of the prior year.

One characteristic reported as of March is age. TRIM3 analysts have generally rejected the options of subtracting one year from each age, or having age vary month by month. To maintain the appropriate age distribution with either of those options, infants would have to disappear from the population, and the recently deceased would have to reappear. To avoid these complexities, TRIM3 typically treats a person's age in March as his or her age for the entire calendar year.

Disability status is used in determining categorical eligibility for SSI, Medicaid, and the elderly and disabled tax credit that may be applied against federal income taxes, but it is not well reported on the March CPS files. The only disability information on the March CPS is indirect. Persons who are not working in the survey week, or who did not work in the prior calendar year, are asked why they did not work; one possible response is "illness or disability." Use of the labor force data may be supplemented by examining whether a potentially disabled person reported receiving a type of income associated with disability. Because neither labor force information nor income data is reported for children, no disabled children can be identified from the March CPS.

Citizenship status affects categorical eligibility for many programs. Illegal aliens are ineligible for assistance under most programs. Depending on the program, other non-citizens may only be allowed categorical eligibility if they meet certain requirements, such as those related to age, disability status, immigrant/refugee status, work history, and length of time in the United States. Since there is only limited citizenship information on the March CPS, Urban Institute demographers and TRIM3 staff have developed sophisticated methodologies to assign immigrant and citizenship status to individuals for most years of the TRIM3 input data. Other personal characteristics used in some categorical eligibility definitions, such as whether or not a woman is pregnant, are not reported at all on the March CPS files. The designer of a simulation module must compare the actual categorical eligibility definition used by a program to the available data to arrive at the operational definition to be used in the simulation.

Determining Assets and Applying Assets Eligibility Tests

Transfer programs generally include assets eligibility tests as well as income tests. The value of assets held by a filing unit is compared to a maximum amount to determine if the unit is eligible. The same program may include multiple assets tests. For example, there may be separate limits for the filing unit's automobile and for other real and personal property.

The March CPS files include no data on asset holdings of any kind. The amount of financial assets can be imputed from asset income: interest, dividends, and rental income. Asset income is converted to asset holdings by assuming that all assets generate income and that all assets have the same rate of return. That rate of return is a program rule in each of the TRIM3 modules performing the assets imputation. Nonfinancial assets tests, such as limits on the value of an automobile, are not simulated in TRIM3.

Determining Income

If a filing unit passes categorical eligibility screens, the next step is generally to compute any income amounts needed by the simulation. A filing unit's transfer program benefits and tax program liabilities depend on how much income, and what kind of income, it has. Simulation modules differ in the accounting period for which income is computed. The tax modules operate on an annual basis, whereas the transfer program modules operate on a monthly basis, counting monthly income and determining monthly benefits.

The exact definition of income varies by program. Most simulation modules include an input variable list program rule that lists the types of income counted by that program. Some programs use different income concepts for different purposes. For example, the Food Stamp Program computes gross income by adding up the earned and unearned income variables specified in input variable list program rules, but then takes deductions from gross income to compute net income.

Three problems arise in determining income for simulation purposes. First, income may be unavailable for some persons. On the March CPS files, income is unavailable for persons under 15 years o1d. Although children under age 15 are very unlikely to have earnings, they may have unearned income, such as Social Security survivor's benefits or SSI payments. Presumably, those dollar amounts are reported on the record of an adult in the household. Second, income may not be reported in sufficient detail for purposes of a particular program. For example, the dollar amount reported as "other" income may include a number of items, some of which are included in a program's income definition and others of which are not. Third, some kinds of income may not be reported in any form. For example, there are no data on capital gains income on the March CPS files. TRIM3 must statistically match data on capital gains income amounts onto the March CPS in order to run the federal income tax simulation.

When a program uses an income concept in which deductions are taken from gross income, additional problems arise. Deductions are generally based on expenditures. For example, home mortgage interest expenses are deductible from income for federal tax purposes, and child-care expenses are a deduction from TANF income. The March CPS does not include expenditure data. Therefore, TRIM3 must impute the expense information needed by a particular simulation. Child care expenses are imputed by the Child Care Expenses module, housing expenses are imputed by the Public and Subsidized Housing module, and expenditures that may be used as deductions in the Federal Income Tax module are statistically matched to the March CPS using data from the Internal Revenue Service's Statistics of Income Public Use File (SOI). Simple imputations of additional expenses are included in some of the modules.

Applying Income Eligibility Tests

Transfer programs generally include an explicit eligibility test involving income. A filing unit is not eligible for the program unless its income, as computed in the manner just described, is beneath a certain maximum. All transfer programs and tax credits include an implicit income test: if the benefit or credit is computed to be zero, a filing unit is obviously ineligible. However, an explicit income test may make ineligible a unit that would otherwise be computed to have a positive benefit.

A transfer program may include more than one income test. The Food Stamp Program includes both a gross income test, comparing gross income to a gross income cutoff, and a net income test, comparing income after certain deductions to a lower cutoff. The income cutoffs used in eligibility tests are entered through TRIM3 program rules.

A tax program may include an explicit tax-filing test based on income. For example, self-employed persons are not required to pay Social Security self-employment tax unless their earnings are over a certain cutoff. The cutoffs used for income-based tests in tax programs are also entered through program rules.

Computing the Benefit or Tax

If a filing unit passes all eligibility tests for a transfer program or is required to file a return for a tax program, the simulation must compute the specific amount of benefit or tax. A tax or benefit formula is applied to the specific income and characteristics of the filing unit. The formula may be simple or complex. To determine federal SSI benefits, a filing unit's income is simply subtracted from an income guarantee. The determination of federal taxes involves multiple tax brackets, surtaxes, and tax credits.

Technically, transfer programs may use "retrospective budgeting," in which this month's benefit is determined based on last month's income. TRIM3 bases a particular month's benefit on that same month's income. Several of the simulated transfer programs have the ability to perform "income smoothing"-in which the variability in month-to-month earnings is reduced by calculating an average monthly paycheck rather than by adding up weekly or bi-weekly paychecks to determine the actual amount of income received in each month.

Making the Participation Decision

The final step in a program simulation may be to simulate program participation. Participation must be simulated when the number of units found to be eligible by the module exceeds the number who actually participate, according to administrative data. Most of the TRIM3 transfer program modules include a simulation of the participation decision. The participation decision is also made for two of the federal tax credits: the elderly and disabled tax credit and the child and dependent care credit.

In each transfer program module, participating filing units are chosen from among those units found to be eligible by the simulation. During each year's baseline simulation, a module's participants are selected in such a way as to meet targets for that year. Targets used in various modules include the overall number of program recipients, different types of participating units, and the numbers of units in different states. When an alternative law is simulated, the number and type of participants will differ owing to changes in the population of eligible units.

The specific methods used to determine participation vary across the transfer program simulations. In general, each eligible unit is given a probability of participation based on its characteristics. The probability may be obtained from a look-up table of probabilities based on only a few characteristics or may be generated by a complex multivariate model. A random number between 0 and 1 is compared to the probability, and if the random number is less than the probability, the unit will participate. Because TRIM3 uses the same random number for each run, the same participation results are produced whenever the same program rules are applied to the same input file.

The simulations can use participation information reported on the March CPS, but cannot rely exclusively on that information. In some modules, the fact that an eligible unit reported receiving the benefit gives that unit automatic participation in the simulation. However, additional participants must be chosen to achieve program targets. Some units that report participating in a particular program are found ineligible by the simulation. Possible reasons for the presence of "ineligible reporters" include reporting errors, coding errors, and the mismatch between March demographic data and annual income data. For example, a single woman with no children in March might have received TANF benefits in the prior year because she had a teenage child living with her at that time. TRIM3 never assigns participation to ineligible reporters.