If Top Rates Must Go Up, Extending Full Expensing Would Ease the Economic Pain

December 05, 2012

At this moment, it looks as though the country is headed over the fiscal cliff. Negotiations between the White House and Congress seem at an impasse. President Obama wants a plan that would boost top tax rates while Congressional Republicans have rejected this notion, and instead propose to raise new revenues through broad-based tax reform.

But the President would seem to have the upper hand in this stalemate. All he needs to do to get his desired rate hike for the rich is to allow the Bush tax cuts to expire on January 1st. He can then force Congress to “cut taxes” for the 99 percent (effectively restoring current policies), while preserving the higher rates for the top 1 percent. Republicans would no doubt lose the public relations war if they stood in the way of “protecting the middle-class.”

So if it looks like top tax rates are going up anyway, what can Congressional Republicans do to mitigate the economic effects? As we reported in our recent study Diving Off the Fiscal Cliff: An Economy on the Rocks, the negative effects of higher income tax rates could be moderated by extending and increasing the current expensing provisions.

For example, the table below compares the economic effects of increasing the top two marginal tax rates alone to the same policy with 50 percent expensing and 100 percent expensing. In isolation, boosting the top two marginal tax rates leads to lower GDP, lower wages, and lower capital stocks. However, adding either of the expensing options lead to an increase in GDP, higher wages, and higher capital stocks.

Adding the 50 percent expensing option would boost long-term GDP by 0.93 percent, while the 100 percent expensing option would boost GDP by 2.28 percent.

Impact of Raising Two Top Marginal Tax Rates vs. Restoring 50% and 100% Expensing
(Dollar figures in billions of 2012 dollars except as noted*)

 

Rise in top two tax rates

Top rate increase

Changes in:

With 50% Expensing

With 100% Expensing

GDP

-0.44%

0.93%

2.28%

Private business GDP

-0.48%

0.94%

2.35%

Private business stocks

-0.99%

2.82%

6.66%

Wage rate

-0.24%

0.93%

2.07%

Private business hours of work

-0.23%

0.02%

0.27%

Federal revenue (dynamic)

$21.4

$50.7

$79.1

Federal spending

-$2.1

$6.0

$14.0

Federal deficit (- = lower deficit)

-$23.4

-$44.6

-$65.1

Static revenue estimate

$37.4

$18.1

-$0.5

% of static revenue lost to dynamic contraction of GDP

-42.8%

N.A.

N.A.

GDP

-$70.0

$146.0

$359.1

GDP drop per $ of (net dynamic) revenue gain**

-$3.60

N.A.

N.A.

Weighted average service price of capital

Corporate

-0.03%

-2.92%

-5.62%

Noncorporate

1.81%

0.76%

-0.31%

All business

0.52%

-1.83%

-4.04%

* The model was run on 2008 income levels. The dollar figures were then indexed to the growth in nominal GDP from 2008 to mid-2012 to show what the equivalent values would be in the current economy. This does not account for changes in the types of income and capital assets since 2008, data for which will not be available from the IRS and Commerce Department for several years.

** If "N.A.", revenues rose in spite of tax “cut” due to rise in GDP.

Either provision turns a GDP loss into a gain with an increase in revenue. Thus, if President Obama insists on increasing the top tax rates, lawmakers can moderate the economic damage by restoring expensing on a permanent basis. We estimate that an expensing rate of 85 percent would fully offset the higher capital costs for pass-through businesses caused by the marginal rate hikes, but full expensing (100 percent) would certainly be better.

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