The Ryan and Murray Budget Plans

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 tax 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 Tax Rate to 10%
• Lower all higher Individual Income Tax Rates to 25%
• Repeal Obama Care HI Surtax
• Repeal Obama Care Investment Income Surtax
• Repeal AMT
• Cut the Corporate 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 income 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 bracket. 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.

*Spending here reflects how tax changes affect federal workers' wages. It does not include the spending proposals by Ryan or Murray.