The House of Representatives is about to vote on a series of Budget Resolutions. One will be the Paul Ryan budget proposal and other will be the Senate budget plan proposed by Senator Murray.
Budget Resolutions specify a revenue floor and a spending target for each budget area, but cannot dictate to the various Committees exactly how they are to hit their targets. Therefore, modeling the economic results of a budget proposal is problematic. In this instance, we have a fairly detailed list of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. changes proposed in Representative Ryan’s blueprint for restoring a balanced budget. The plan is less specific on spending reductions. The Murray plan is more vague, on both sides. Nonetheless, one can make a broad comparison of the two approaches.
The Ryan plan would reduce tax rates and spending significantly. The Murray plan would have far smaller reductions in spending and would raise taxes significantly. History and sound economic theory tell us that a smaller government and lower tax rates mean a larger private sector and larger overall level of GDP. A larger government and higher tax rates mean a smaller private sector and total GDP.
We have modeled the economic consequences of tax changes roughly consistent with the two policy proposals. We do not model the economic effects of the proposed government spending reductions. Government transfer payments add nothing to production and national income, and, through the disincentive effect of promising benefits without people having to work and save for them, probably reduce output. Government spending on goods and services is part of GDP, but does not add to it. It diverts resources from private to public use, and displaces private production and consumption. On balance, it probably reduces the value of national output by diverting it to products the public would not normally favor. Government spending would add to GDP primarily in those limited cases of infrastructure investment that adds more to productivity and GDP than private investment would do. These are a small fraction of the federal budget.
The Ryan plan:
We have modeled the following Ryan proposals:
- Lower the 15% Statutory Individual Income TaxAn individual income tax (or personal income tax) is levied on the wages, salaries, investments, or other forms of income an individual or household earns. The U.S. imposes a progressive income tax where rates increase with income. The Federal Income Tax was established in 1913 with the ratification of the 16th Amendment. Though barely 100 years old, individual income taxes are the largest source of tax revenue in the U.S. Rate to 10%
- Lower all higher Individual Income Tax Rates to 25%
- Repeal Obama Care HI SurtaxA surtax is an additional tax levied on top of an already existing business or individual tax and can have a flat or progressive rate structure. Surtaxes are typically enacted to fund a specific program or initiative, whereas revenue from broader-based taxes, like the individual income tax, typically cover a multitude of programs and services.
- Repeal Obama Care Investment Income Surtax
- Repeal AMT
- Cut the Corporate Income TaxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. Rate to 25%
The Ryan tax reductions would raise GDP and labor income by a bit over 6% after all adjustments (about five to ten years after full implementation). That is roughly equivalent to 8 million additional full time jobs at current wages. GDP would rise by $6.20 for each dollar of net tax increase (saving the taxpayers $7.20). Over half of the assumed revenue loss would be recovered from increased GDP and employment. To be clear, the growth calculated for the Ryan plan assumes the residual revenue losses (after feedback from the added economic growth) are covered by restraining spending, or by reducing tax preferences that are unrelated to incremental economic effort and would not discourage capital formation, hours worked, or labor force participation.
The static distribution of the tax cuts would be skewed toward the upper income, in large part because the plan repeals the Obama Care tax increases and some of the fiscal cliff tax hikes that were skewed toward the upper income. (Relative to the 2012 tax system, the tax changes would be much more uniform across income levels.) The static distribution table does not include the corporate tax rate changes, which are more broadly distributed throughout the economy. After accounting for the positive economic changes, including the increased work hours and wages, after-tax incomeAfter-tax income is the net amount of income available to invest, save, or consume after federal, state, and withholding taxes have been applied—your disposable income. Companies and, to a lesser extent, individuals, make economic decisions in light of how they can best maximize their earnings. rises substantially across all income classes under the Ryan proposal. See tables below.
The Murray plan:
We have modeled the Murray tax plan as a limitation on the benefits of itemized deductions to 15% of the amount, as if they were applied solely against income in the 15% tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. . This in the spirit of a proposal in the President’s FY 2012 budget submission. In addition to tax increases on the upper income, Murray also recommends extending a number of refundable credits. These have limited economic effects, and are not modeled. The deduction limitation raises about as much revenue on a static basis as is needed to cover the stimulus proposals, sequestration repeal, refundable credits, and net revenue gains in the Murray plan. Note that there are many alternative ways in which the tax committees could achieve the revenue targets.
The tax increase would reduce GDP and labor income by a bit under 1% after all adjustments. That is roughly equivalent to a loss of a million full time jobs at current wages. GDP would fall by $1.60 for each dollar of net tax increase (costing the taxpayers $2.60). Over a quarter of the assumed revenue gains would be lost to reduced GDP and employment.
The static revenue estimates show the Murray tax increase falling mainly on people in the upper income brackets. After adding in the negative economic effects, including the reduced work hours and wages, it can be seen that after-tax income would fall at all income levels (excluding refundable credits). See tables below.
Conclusion
The economy would be stronger under the smaller government and lower tax rates of the Ryan Budget than under the Murray budget. Congress should be aware that the health of the economy is enhanced as the federal budget is reduced (certainly from the historically high levels that have existed since 2009). The idea that a larger federal sector is good for economic growth was a mistaken lesson dating back to the Great Depression. It is time we moved on.
Comparison of Economic and Budget Changes Versus 2013 Law(billions of 2012 dollars except as noted) |
||
|
Ryan Budget |
Murray Budget |
|
|
GDP |
6.29% |
-0.82% |
|
Private business GDP |
6.68% |
-0.92% |
|
Private business stocks |
15.62% |
-1.26% |
|
Wage rate |
3.96% |
-0.13% |
|
Private business hours of work |
2.62% |
-0.79% |
|
Federal revenue (dynamic)($ billions) |
-$175.7 |
$86.3 |
|
Federal spending ($ billions)* |
$31.4 |
-$2.5 |
|
Federal surplus (+ = lower deficit) ($ billions) |
-$207.1 |
$88.8 |
|
Static revenue estimate ($ billions) |
-$366.5 |
$116.9 |
|
% Revenue reflow vs. static |
-52.1% |
-26.2% |
|
$GDP ($ billions) |
$992.9 |
-$130.1 |
|
$GDP gain/$net tax decrease (dollars) |
$6.2 |
-$1.6 |
*Spending here reflects how tax changes affect federal workers' wages. It does not include the spending proposals by Ryan or Murray.
Comparison of Income Distribution Effects(2012 dollars) |
||||||||
|
AGI Class |
Ryan Budget |
Murray Budget |
||||||
|
Average after-tax income per return |
Average after-tax income per return |
|||||||
|
Static |
Static |
Dynamic |
Dynamic |
Static |
Static |
Dynamic |
Dynamic |
|
|
< 0 |
$183 |
-0.19% |
-$6,316 |
6.54% |
$0 |
0.00% |
$877 |
-0.91% |
|
0 – 5,463 |
$1 |
0.02% |
$176 |
6.23% |
$0 |
0.00% |
-$22 |
-0.78% |
|
5,463 – 10,925 |
$0 |
0.00% |
$503 |
6.18% |
$0 |
0.00% |
-$65 |
-0.80% |
|
10,925 – 21,850 |
$10 |
0.06% |
$988 |
6.10% |
$0 |
0.00% |
-$126 |
-0.78% |
|
21,850 – 32,775 |
$163 |
0.60% |
$1,766 |
6.53% |
$0 |
0.00% |
-$202 |
-0.75% |
|
32,775 – 43,700 |
$429 |
1.13% |
$2,638 |
6.94% |
-$30 |
-0.08% |
-$301 |
-0.79% |
|
43,700 – 54,625 |
$708 |
1.45% |
$3,409 |
6.96% |
-$286 |
-0.58% |
-$617 |
-1.26% |
|
54,625- 81,938 |
$1,135 |
1.69% |
$4,784 |
7.13% |
-$453 |
-0.67% |
-$901 |
-1.34% |
|
81,938 – 109,250 |
$1,925 |
2.04% |
$6,881 |
7.29% |
-$1,124 |
-1.19% |
-$1,709 |
-1.81% |
|
109,250 – 163,875 |
$2,430 |
1.85% |
$8,747 |
6.66% |
-$2,415 |
-1.84% |
-$3,212 |
-2.45% |
|
163,875 – 218,500 |
$3,072 |
1.64% |
$12,113 |
6.48% |
-$3,694 |
-1.98% |
-$4,809 |
-2.57% |
|
218,500 – 273,125 |
$6,327 |
2.61% |
$18,143 |
7.48% |
-$4,290 |
-1.77% |
-$5,631 |
-2.32% |
|
273,125 – 546,250 |
$18,246 |
4.98% |
$35,884 |
9.78% |
-$5,756 |
-1.57% |
-$7,787 |
-2.12% |
|
546,250 – 1,092,500 |
$55,353 |
7.49% |
$91,343 |
12.35% |
-$16,013 |
-2.17% |
-$19,977 |
-2.70% |
|
> 1,092,500 |
$343,625 |
9.55% |
$524,789 |
14.59% |
-$69,636 |
-1.94% |
-$90,380 |
-2.51% |
|
TOTAL FOR ALL |
$1,987 |
3.28% |
$5,141 |
8.48% |
-$752 |
-1.24% |
-$1,132 |
-1.87% |