The Republican tax reform framework’s corporate elements, namely a statutory rate cut and full, immediate expensing, could increase long-term GDP 3 percent to 5 percent, depending on whether expensing expires after five years, and on company expectations, the Council of Economic Advisers (CEA) said October 27.
The CEA offered that finding in a new report that expanded on its previous tax reform white paper that found that the framework’s corporate changes would ultimately increase average U.S. household income roughly $4,000 each year.
In a press call before the new report’s release, CEA Chair Kevin Hassett said the council found that three types of economic model — macro time series, general equilibrium, and cost of capital — all strongly supported that finding. D.J. Nordquist, Hassett’s chief of staff, told Tax Analysts that the new report also compared the models’ results to economic literature on how tax changes affect wage growth.
The CEA highlighted the business cost recovery provision’s impact in a narrower estimate that overtly paired it with reduction of the statutory corporate tax rate from 35 percent to 20 percent, under a user cost of capital model. That approach simulates how taxes affect the financial opportunity-cost companies face when considering an investment.
“The user cost modeling is simple if expensing is permanent, but the current plan calls for it to expire after five years,” the CEA said. The framework states that expensing would be enacted “for at least five years.”
The CEA continued: “In a forward-looking, rational expectations model, firms would look ahead to the [provision’s expiration] and respond less . . . because their long-run target capital stock would be lower than for a permanent change.”
“Based upon user-cost elasticity estimates, our calculations show that [the statutory rate cut] combined with permanent full expensing of capital investment would raise long-run GDP by between 3 and 5 percent,” the CEA said. “Our estimates indicate a 0.5 percent increase over the baseline [Congressional Budget Office] forecast in year one and a 4.2 percent increase in the long-run steady state.”
Eliminating full expensing after five years "would reduce the long-run steady state increase in GDP to 3.1 percent,” the CEA added. The CEA then compared its preliminary estimate with the economic literature and concluded that the framework’s corporate elements would likely yield a 3 percent to 5 percent GDP increase.
Under Hassett’s leadership, the CEA has faced harsh criticism for its estimates of tax reform’s economic effects, including accusations of shoddy analysis and willful misinformation. The new report seemed unlikely to reduce that polarization, based on initial reaction to it.
Steven M. Rosenthal of the Urban-Brookings Tax Policy Center (TPC) castigated the paper: “The CEA is trying to overwhelm the public with mumbo-jumbo — and analysis that is implausible.”
However, a former Hassett colleague came to the CEA’s defense, challenging its critics.
“From the empirical and theoretical work cited, the CEA calculation is straightforward and reasonable,” said American Action Forum Director of Fiscal Policy Gordon Gray, who said he worked for Hassett as a research assistant right after college. “I think the CEA paper is transparent in its methodology and well-grounded in the relevant tax literature,” Gray said.
“What criticism I’ve seen of CEA’s estimates — and that criticism should be discounted for its uniquely personal tenor — has essentially been rooted in a reflexive ‘it’s too high,’ reaction,” Gray told Tax Analysts, pointing favorably to mathematical rebuttals of the criticism by economists including former CEA Chair Greg Mankiw.
Gray challenged the CEA estimates’ critics to “articulate specific objections to the points raised in [the] paper, rather than indulge in the type of ad hominem attacks that have characterized this debate over the last few days.”
Downbeat Dynamic Analysis
Aspects of the unified GOP framework would cause a modest increase in GDP if dynamic estimates are taken into account, according to an updated TPC analysis.
With the framework in place, GDP would be boosted by between 0.3 and 0.9 percent in fiscal 2018. By 2027, GDP would range from a 0.1 percent reduction to a 0.3 percent increase, and in 2037 the range would be between a 0.4 percent reduction and a 0.1 percent reduction.
“The economic effects of the framework would in turn alter the revenue effect of the proposal, increasing them (relative to revenues before macro feedback) by between $4 billion and $31 billion in fiscal year 2018. Between 2018 and 2027 the estimated feedback effect ranges from an increase of $52 billion to a decrease of $56 billion, and between 2028 and 2037 it ranges from a decrease of $155 billion to a decrease of $176 billion,” according to the analysis.
“The estimated effects on output become more negative over time primarily due to the crowding out effects of rising deficits,” according to the analysis.
The TPC's dynamic estimates also show that proposals in the framework would increase aggregate demand; increase tax rates on investment income for lower-income households while reducing them in higher-income households; and “modestly” reduce effective tax rates on labor income by reducing marginal tax rates for most workers.
An earlier version of the TPC report, issued September 29, estimated that the framework would reduce federal revenue by $2.4 trillion over a decade. The TPC attributed a $2.6 trillion loss to tax changes on the business side, including passthrough-related provisions; a $240 billion loss from eliminating the estate and gift taxes; and roughly $470 billion of additional revenue from altering individual income tax provisions.
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