How The Presidential Tax Proposals Could Affect Aggregate Demand ...
How The Presidential Tax Proposals Could Affect Aggregate Demand, Output, and Revenue October 17, 2016 Benjamin R. Page Dynamic Scoring of Tax Proposals
TPC’s Conventional Analysis of the Tax Plans • Uses a microsimulation model based on a large sample of tax returns • Allows for behavorial responses – Higher tax rates lead to lower taxable income due to changes in reporting – Tax rates influence capital gains realizations, purchases of particular goods • Does not incorporate changes to macroeconomic outcomes such as output www.taxpolicycenter.org
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TPC’s Conventional Analysis of the Clinton Plan • Raises marginal and average tax rates on many high-income households • Reduces taxes for lower-income households • Increases business taxes • Revenues increased by $1.4 trillion over 2017-2026
www.taxpolicycenter.org
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Ways the Clinton Plan Would Affect the Economy • Reduces after-tax incomes • Increases marginal tax rates on labor income, reducing labor supply • Increases marginal tax rates on capital income, reducing private saving and investment • Reduces budget deficits, increasing national saving and investment www.taxpolicycenter.org
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TPC’s Conventional Analysis of the Trump Plan • Reduces average and marginal tax rates on most households – Biggest reductions flow to high-income households • Reduces taxes on corporate and other business income • Revenues reduced by $6.2 trillion over 20172026 www.taxpolicycenter.org
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Ways the Trump Plan Would Affect the Economy • Increases after-tax incomes • Reduces marginal tax rates on labor income, increasing labor supply • Reduces marginal tax rates on capital income, increasing private saving and investment • Increases budget deficits, reducing national saving and investment www.taxpolicycenter.org
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Dynamic Scoring • Macroeconomic effects influence revenues, but also useful information for assessing desirability of tax policy changes • Other features of tax policy more central than macro effects – Level of revenues – Distribution of tax burden • Tax policy affects the economy at the margins www.taxpolicycenter.org
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Two Approaches to Dynamic Analysis • Keynesian – Effects stem from changes in demand – Equations relate aggregate variables – Output changes relative to its potential level – Output returns to potential after a few years • Overlapping generations – Effects stem from behavior at household level – Households respond to incentives to work and save – Households forward-looking – Output equals potential www.taxpolicycenter.org
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TPC Keynesian Model • Estimates effects in two stages 1. Direct effect of policy on demand 2. Indirect effects of initial change in demand • Model employs a range of assumptions for both direct and indirect effects • Effects fade over four years www.taxpolicycenter.org
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Direct Effect on Demand • With more after-tax income, consumers spend more – Lower-income households spend a larger share of their additional income than higher-income households do – Baseline assumption: • Lowest quintile spends 90 cents of each additional dollar • Highest quintile spends just 55 cents of each additional dollar
• Investment incentives lead firms to invest more • Higher wealth leads consumers to spend more www.taxpolicycenter.org
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Indirect Effects on Demand • Direct effect generates further, indirect effects that can add to or offset the direct effect – On the plus side, increased demand can lead to increased hiring, investment spending, or consumption spending – On the minus side, increased demand could lead to higher interest rates, reducing investment and consumer spending www.taxpolicycenter.org
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Indirect Effects on Demand • In normal economic times the Fed offsets expansionary tax policy by raising rates to prevent increase in inflation • In deep recession the Fed will not change rates • TPC’s Keynesian model assumes 2017 will be a blend of those two states, and following years will be “normal” • In 2017 indirect effects offset 1/6 of direct effects; in later years 1/2 www.taxpolicycenter.org
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Clinton Tax Plan • Increases taxes on average – With lower incomes, people spend less – Biggest increases fall on to high-income households – Mutes spending decline
www.taxpolicycenter.org
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Trump Tax Plan • Cuts taxes for most households – With higher incomes, people spend more – Biggest cuts go to high-income households • Mutes spending increase
• Expensing provision encourages firms to boost investment spending www.taxpolicycenter.org
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TPC’s Conventional Analysis of the Tax Plans • Uses a microsimulation model based on a large sample of tax returns • Allows for behavorial responses – Higher tax rates lead to lower taxable income due to changes in reporting – Tax rates influence capital gains realizations, purchases of particular goods • Does not incorporate changes to macroeconomic outcomes such as output www.taxpolicycenter.org
1
TPC’s Conventional Analysis of the Clinton Plan • Raises marginal and average tax rates on many high-income households • Reduces taxes for lower-income households • Increases business taxes • Revenues increased by $1.4 trillion over 2017-2026
www.taxpolicycenter.org
2
Ways the Clinton Plan Would Affect the Economy • Reduces after-tax incomes • Increases marginal tax rates on labor income, reducing labor supply • Increases marginal tax rates on capital income, reducing private saving and investment • Reduces budget deficits, increasing national saving and investment www.taxpolicycenter.org
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TPC’s Conventional Analysis of the Trump Plan • Reduces average and marginal tax rates on most households – Biggest reductions flow to high-income households • Reduces taxes on corporate and other business income • Revenues reduced by $6.2 trillion over 20172026 www.taxpolicycenter.org
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Ways the Trump Plan Would Affect the Economy • Increases after-tax incomes • Reduces marginal tax rates on labor income, increasing labor supply • Reduces marginal tax rates on capital income, increasing private saving and investment • Increases budget deficits, reducing national saving and investment www.taxpolicycenter.org
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Dynamic Scoring • Macroeconomic effects influence revenues, but also useful information for assessing desirability of tax policy changes • Other features of tax policy more central than macro effects – Level of revenues – Distribution of tax burden • Tax policy affects the economy at the margins www.taxpolicycenter.org
6
Two Approaches to Dynamic Analysis • Keynesian – Effects stem from changes in demand – Equations relate aggregate variables – Output changes relative to its potential level – Output returns to potential after a few years • Overlapping generations – Effects stem from behavior at household level – Households respond to incentives to work and save – Households forward-looking – Output equals potential www.taxpolicycenter.org
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TPC Keynesian Model • Estimates effects in two stages 1. Direct effect of policy on demand 2. Indirect effects of initial change in demand • Model employs a range of assumptions for both direct and indirect effects • Effects fade over four years www.taxpolicycenter.org
8
Direct Effect on Demand • With more after-tax income, consumers spend more – Lower-income households spend a larger share of their additional income than higher-income households do – Baseline assumption: • Lowest quintile spends 90 cents of each additional dollar • Highest quintile spends just 55 cents of each additional dollar
• Investment incentives lead firms to invest more • Higher wealth leads consumers to spend more www.taxpolicycenter.org
9
Indirect Effects on Demand • Direct effect generates further, indirect effects that can add to or offset the direct effect – On the plus side, increased demand can lead to increased hiring, investment spending, or consumption spending – On the minus side, increased demand could lead to higher interest rates, reducing investment and consumer spending www.taxpolicycenter.org
10
Indirect Effects on Demand • In normal economic times the Fed offsets expansionary tax policy by raising rates to prevent increase in inflation • In deep recession the Fed will not change rates • TPC’s Keynesian model assumes 2017 will be a blend of those two states, and following years will be “normal” • In 2017 indirect effects offset 1/6 of direct effects; in later years 1/2 www.taxpolicycenter.org
11
Clinton Tax Plan • Increases taxes on average – With lower incomes, people spend less – Biggest increases fall on to high-income households – Mutes spending decline
www.taxpolicycenter.org
12
www.taxpolicycenter.org
13
www.taxpolicycenter.org
14
www.taxpolicycenter.org
15
Trump Tax Plan • Cuts taxes for most households – With higher incomes, people spend more – Biggest cuts go to high-income households • Mutes spending increase
• Expensing provision encourages firms to boost investment spending www.taxpolicycenter.org
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