President’s $1.6 Trillion Tax Bid Lowers GDP, Wages, Living Standards

According to this morning’s Washington Post, President Obama’s opening tax offer in his negotiations with Congress over the Fiscal Cliff is the $1.6 trillion in new taxes that were the centerpiece of his FY 2013 budget. Recently, Tax Foundation economists used our Tax and Macroeconomic Model to simulate the long-term economic impact of the President’s proposals – specifically, his proposals to increase taxes on high-income taxpayers [full report here].

In short, the model results indicate that the President’s plan would not only lower GDP and capital formation, but it would reduce after-tax incomes for every household – not just families hit by the higher taxes.

As Table 1 shows, the tax plan would increase federal revenues by $136 billion per year (in 2008 dollars). However, after accounting for the economic effects of the tax increases, fully 70 percent of the expected static revenue gain from the plan would be lost due to the dynamic effects of slower economic growth. For every $1 the plan would raise, GDP would fall by more than $10. That would seem like a poor tradeoff.

Revenue gains would be due entirely to the rise in the two top tax rates and the restoration of the PEP and Pease provisions. The capital gains and dividend tax rate increases would be so economically harmful that they would eventually reduce revenues, when all types of federal taxes are considered. The same is true of the increase in the estate tax.

Table 1: Economic and Federal Budget Effects of Major Tax Proposals in President Obama's Budget

Percent or dollar changes* in:

Combined Obama Budget Tax Proposals

Raise Top Rates on Capital Gains and Dividend

Raise Top Two Tax Rates on High Incomes

Raise Estate Taxes to 2009 Levels

Restore PEP and Pease

GDP (%)






Private business GDP (%)






Private business stocks (%)**






Wage rate (%)






Business hours worked (%)






Federal revenue (static est., $)






Federal revenue (dynamic est., $)






Federal spending ($)






Federal deficit (+ = lower deficit, $)






% Dynamic revenue reflow vs. static est.***






GDP ($)






GDP/$ dynamic tax reduction****






Note: All dollar figures are in billions of 2008 dollars. The simulation was run separately for each provision, and because of interactions the separate effects do not necessarily add up to the total effect of all provisions.

†PEP and Pease are the phase-outs of personal exemptions and up to 80 percent of itemized deductions for upper-income taxpayers that were in force before the Bush tax cuts.

*These changes represent the cumulative increase or decrease in the permanent level of GDP and other variables after all economic adjustments to the tax changes, taking five to ten years. They are not permanent changes in the annual rates of growth of the variables. The model and tax calculator were run at 2008 income levels; dollar figures are in 2008 dollars.

**Private business sector equipment, plant, other buildings and structures, inventory, etc.

***Percent of static tax cut recovered (+) due to faster economic growth, or percent of static tax increase lost (-) to slower economic growth.

****Negative numbers indicate the drop in GDP per dollar of increased federal revenue, after dynamic effects. N.A. indicates that the tax rate increase would actually lose revenue due to its adverse effects on the economy.

Distributional Affects: Losses in After-Tax Income Across the Board

The loss in GDP and incomes from the president's tax plan would be widely shared. Every income group would experience at least a 2.6 percent decrease in after-tax income from reduced wages and earnings on savings.

Regardless of the initial distribution of a tax change, the economic reactions to a tax increase distribute the economic losses (or gains in the event of a tax decrease) across the board. Tax increases on capital formation harm labor by reducing productivity, wages, and employment. Tax decreases on capital raise productivity, wages, and employment. The differences between the static and dynamic consequences of the Obama tax package are displayed below for all income classes.

Table 2: Distribution of Income Effects of the Obama Income and Estate Tax Plan

Average Change per Return (in 2008 dollars)

Percent Changes

Adjusted Gross Income Class (2008 dollars)

Static After -Tax Income

Dynamic After-Tax Income

Static After-Tax Income

Dynamic After-Tax Income

< 0





0 – 5,000





5,000 – 10,000





10,000 – 20,000





20,000 – 30,000





30,000 – 40,000





40,000 – 50,000





50,000 – 75,000





75,000 – 100,000





100,000 – 150,000





150,000 – 200,000





200,000 – 250,000





250,000 – 500,000





500,000 – 1,000,000





> 1,000,000










The static changes in after-tax income are due solely to the average initial tax increase per tax return in the upper income classes. The post-economic adjustment decreases in after-tax incomes across-the-board are the sum of the tax increase plus the projected decrease in income due to the slower growth in the economy compared to the baseline (which will also affect the tax due to the government). Low-income taxpayers (those earning less than $50,000) are shown to suffer a roughly $75 to $1,100 decrease in after-tax income as a result of the tax program, on a dynamic basis, even though these filers face no initial tax cuts on a static basis. For them, nearly all the reductions in income are due to a weaker economy and lower wages and hours worked.

Lawmakers must recognize that the economic impact of raising taxes on the “rich” extend well beyond those high-income taxpayers.


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