How to Use This Tool

The figures reported in this book were estimated using the Tax Foundation’s General Equilibrium Model, with the goal of providing a comprehensive picture of how different tax changes would affect the US economy, federal tax revenue, the long-term debt-to-GDP trajectory, and the distribution of after-tax income.

Each option described in this book is accompanied by several statistics that summarize the projected long-run economic effects, 10-year revenue effects (calendar years), and distributional effects of the tax change relative to a current law baseline.

Understanding the Statistics

Long-Run Change in Gross Domestic Product (GDP)

This statistic conveys how much larger or smaller the US economy would be in the long run if a particular tax change were adopted. It measures the final value of goods and services produced within the United States (by Americans and foreigners) within a given time frame.

For instance, if an option results in a 1 percent increase in long-run GDP, this means that adopting the option would make the US economy 1 percent larger than otherwise. This statistic does not convey any information about how annual GDP growth would change along the adjustment path to the new level because of an option.

Long-Run Change in Gross National Product (GNP)

This statistic conveys how much larger or smaller American incomes would be because of a particular tax change. It is related to GDP but differs because it measures the income that Americans earn from the production of goods and services within the United States and abroad within a given time frame.

Some tax changes can create a wedge between GDP (American output) and GNP (American incomes). Taxes levied on domestic saving, such as capital gains taxes, would reduce the return to saving and the ownership of American investment by domestic residents. Additionally, higher deficits lead to higher government borrowing, which, in turn, could crowd out domestic savers. Because the US economy is open to international investment, foreign investors who are not subject to the tax may provide additional funds to finance domestic investments. In general, this limits the impact that taxes on saving have on GDP because foreign investors continue to fund investments, but the returns to those investments do not benefit Americans, resulting in lower GNP.

Long-Run Change in Capital Stock

This statistic conveys how much larger or smaller the US capital stock would be in the long run if a particular tax change were adopted. The capital stock is a measure of the level of fixed assets in the economy, including government-owned and privately owned. The private stock consists of four main asset types: equipment and software, nonresidential structures, residential structures, and intellectual property.

An increase (or decrease) in the after-tax rate of return to capital will drive an increase (or decrease) in the capital stock. An increase (or decrease) in the level of the capital stock permanently changes output, which increases (or decreases) the incomes for both owners of capital and workers.

Long-Run Change in Wages

This statistic conveys how much larger or smaller the level of real average hourly earnings for employees in all sectors would be in the long run if a particular tax change were adopted.

Long-Run Change in Full-Time Equivalent Jobs

This statistic conveys how much larger or smaller the labor supply would be if a particular tax change were adopted. The labor supply response is measured in hours worked, which is then converted into a measure of full-time equivalent jobs. For example, in 2024, the United States had roughly 161 million employees, but some of them worked part-time jobs. Converted to full-time equivalent employees, which expresses how many employees there would be if Americans worked the same total number of hours but only in full-time jobs, the United States had roughly 145 million full-time equivalent employees in 2024. Many of the options in this book would increase or decrease the capacity of the economy to employ labor, leading to additional or fewer full-time equivalent jobs.

10-Year Primary Deficit Change (Conventional)

This statistic conveys how much a tax policy change would increase or decrease the primary deficit (the difference between revenues and noninterest spending) if it had no macroeconomic effect (in other words, holding the size of the economy constant). It is measured in calendar years. In some cases, the change in revenue over the first 10 years may differ from the long-run change in revenue. This could be due to tax changes that “frontload” or “backload” the revenue impact or due to changes with other timing-related impacts, such as phaseouts or expirations that are scheduled to occur under current law. Except in the case of refundable tax credits, which affect government outlays, government spending is assumed to be unchanged. For some options, such as a value-added tax, this does not capture all the net budgetary effects.

10-Year Primary Deficit Change (Dynamic)

This statistic expresses how much a tax policy change would increase or decrease the primary deficit after considering its economic effects in calendar years. For instance, if cutting the income tax would lead to an increase in hours worked, in turn increasing payroll tax revenue, then it would make up for some of the revenue lost from the income tax cut. Dynamic revenue scores offer a more complete picture of how much federal revenue would change because of a tax change. Note that the long-run revenue change after all adjustments have occurred may be considerably different from the revenue change over the 10-year budget window because economic effects build over time. Except in the case of refundable tax credits, which affect government outlays, government spending is assumed to be unchanged. For some options, such as a value-added tax, this does not capture all the net budgetary effects.

10-Year Total Deficit Change (Conventional)

This statistic expresses the total change in deficits, including changes in interest costs, within the 10-year budget window in calendar years, before considering macroeconomic effects. Holding government spending constant, a change in tax revenue necessitates a change in government borrowing: if revenue goes down, then the government must borrow more to fill the gap, and if revenue goes up, then the government will borrow less. Accordingly, to evaluate the total impact of a tax change on the deficit, one must consider how it will change future interest payments, not just revenues.

10-Year Total Deficit Change (Dynamic)

This statistic combines the two points above, factoring in both how a change in the size of the economy may change revenue collections and how a change in revenue may change interest payments. As a result, it provides a more complete picture of how a policy would shape the overall fiscal picture within the 10-year budget window in calendar years.

Baseline, Conventional, and Dynamic Debt-to-GDP Ratios

The debt-to-GDP ratio compares the size of publicly held federal debt to the economy’s annual output. It is a measure of the federal debt burden. We convert fiscal year projections from the CBO to calendar year projections.

Accordingly, the converted projections show that in 2036, the end of the current 10-year budget window, the debt-to-GDP ratio will reach 120.8 percent, and by 2056, it will reach 175.9 percent.

For each option, we estimate how the projected debt-to-GDP ratio changes across calendar years 2027 through 2056 on a conventional basis with interest cost changes (excluding the macroeconomic impact of the tax policy change) and a dynamic basis with interest cost changes (including the macroeconomic impact).

The estimates illustrate how both the revenue effects and the economic effects stemming from different tax policy changes must be considered to evaluate how an option changes the US fiscal position in the near term and the long term.

Change in After-Tax Income

Most tax changes deliver different costs and benefits to different groups of taxpayers.

Conventional distributional estimates show how after-tax income changes across the income scale, holding the size of the economy constant. To show how much an option would raise or lower taxes on each group, we calculate the tax change as a percentage of the group’s after-tax income. We show the conventional distribution in the first year and last year of the 10-year budget window to illustrate how the provision would impact taxpayer incomes over the budget window.

In addition to costing or benefiting taxpayers through higher or lower taxes, the options in this book would also cost and benefit taxpayers through economic effects. Dynamic distributional estimates show how the after-tax incomes of each group of taxpayers would change due to both direct tax changes and indirect economic effects.

To produce distributional tables, Tax Foundation ranks each tax unit by market income. Market income includes adjusted gross income (AGI) plus tax-exempt interest, non-taxable Social Security income, the employer share of payroll taxes, imputed corporate tax liability, employer-sponsored health insurance and other fringe benefits, and taxpayers’ imputed contributions to defined-contribution pension plans. Market income levels are adjusted for the number of exemptions reported on each return to make tax units more comparable. After-tax income is market income less: individual income tax, corporate income tax, payroll taxes, estate and gift tax, customs duties, and excise taxes.

Key Concepts

Tax Policy Is About Trade-Offs

A famous economist once said, “There are no solutions, there are only trade-offs.” That lesson is especially true in tax policy.

The scales of justice may have two trays, but tax policy has three that lawmakers must balance—revenue, equity, and economic growth.

In other words, in tax policy, policymakers must reckon with an ever-present trade-off between (1) how much revenue a tax will raise, (2) progressivity, or who will bear the burden of a tax, and (3) how a tax change will impact economic incentives.

After modeling more than 80 changes to the tax code, we have found that it is impossible to balance all three equally. Lawmakers will have to decide which of the three is most important based on their values and priorities.

For example, if lawmakers want to make the tax code more progressive and raise revenues, our modeling shows that they will likely have to give up some economic output, because higher tax rates dampen economic activity (especially higher taxes on capital and labor).

And less growth means raising less revenue.

If lawmakers want to generate more economic output, our modeling shows that they will likely have to give up some progressivity, and maybe some tax revenue—although, all things being equal, a larger economy will tend to generate more tax revenue than the baseline, making up for some of the lost revenue.

Our modeling also illustrates that, contrary to popular belief, few, if any, tax cuts pay for themselves. And even the most powerful, pro-growth tax reforms would not allow us to grow our way out of our debt problem.

Some Tax Policy Changes Affect the Economy More Than Others

People’s willingness to work and deploy capital drives economic growth. Changes in the tax treatment of capital and labor change the cost of capital and the cost of labor and therefore affect the size of the capital stock and the supply of labor.

Taxes influence people’s decisions about joining the workforce and how many hours to work. Taxes also influence decisions about how much to invest in new plant and equipment and where to locate new investment. How much the capital stock and the labor supply expand, or contract, largely determines the level of output and income in the economy.

Importantly, under standard economic theory, taxes affect behavior when they apply “on the margin”—when they affect a person’s decision about his next hour of labor or her next dollar of investment.

For instance, changes in marginal tax rates affect people’s incentives differently than lump-sum tax credits. Imagine a policy that cuts the bottom tax bracket from 10 percent to 5 percent. Currently, taxpayers who fall into the bottom bracket keep 90 cents of every additional dollar they earn working. Under this proposed policy, taxpayers in the bottom bracket would keep 95 cents of every additional dollar they earn working. Thus, this policy would give low-income taxpayers a stronger incentive to increase their supply of labor, because they would be able to keep more of their additional earnings.

On the other hand, imagine a policy that gave a fully refundable $2,000 tax credit to every individual. That policy would cut taxes significantly for every single taxpayer. However, it would not have any effect on taxpayers’ supply of labor. Taxpayers in the 10 percent bracket would still only receive 90 cents of each additional dollar they earn working. Because this policy would not change taxpayers’ marginal tax rates, it would not alter labor supply incentives.

Empirical evidence demonstrates that capital is far more sensitive to changes in tax policy than labor is, primarily because capital is far more mobile than labor. Capital can move quickly from jurisdiction to jurisdiction in search of lower tax costs, but it is more difficult for workers to move their families from place to place to lower their tax bills.

Accordingly, changes in the taxation of capital have a larger effect on the economy than changes in the taxation of labor. To illustrate, compare the following two options: introducing full expensing for all structures (Option 54) and reducing the employer-side and employee-side payroll tax by one percentage point each (Option 42). Expensing provides a tax cut for new capital investment, while lower payroll taxes provide a tax cut for labor income.

Full Expensing for Structures (Option 54) compared with an Employer-Side and Employee-Side Payroll Tax Cut (Option 42)

	Full Expensing for Structures	Employer-Side and Employee-Side Payroll Tax Cut
Gross Domestic Product	1.5%	0.5%
Gross National Product	1.4%	0.2%
Capital Stock	2.8%	0.6%
Pre-Tax Wage Rate	1.2%	Less than +0.05%
Full-Time Equivalent Jobs	400,000	555,000
10-Year Primary Deficit Change, Conventional ($ Billions)	$536.8	$2,468.0
10-Year Primary Deficit Change, Dynamic ($ Billions)	-$433.5	$2,004.3
10-Year Total Deficit Change, Conventional ($ Billions)	$648.8	$2,971.8
10-Year Total Deficit Change, Dynamic ($ Billions)	-$474.9	$2,415.1

Note: A negative number is a decrease in the deficit.

Full expensing for structures allows businesses to immediately deduct the cost of long-lived assets like factories, warehouses, offices, and apartment buildings, which increases the return to capital. Reducing the payroll tax by 1 percentage point increases the return to labor, as workers fully bear both sides of the payroll tax.

Compared to the payroll tax cut, expensing for structures would have a substantially larger positive effect on output (GDP, the final value of goods and services produced in America) as well as national income (GNP, the final value of goods and services owned by Americans), and yet would cost substantially less in terms of reduced federal revenue.

Full expensing for structures offers more “bang for the buck” than reducing the payroll tax because expensing reduces taxes on capital, while the payroll tax falls squarely on labor.

The Tax Base Is Just as Important as the Tax Rate

Changing a tax rate might seem like the easiest way to provide tax relief or increase revenue, but the tax rate only matters because of the tax base to which it applies.

Currently, numerous deductions, exclusions, and exemptions narrow the size of the US tax base and reduce the amount of economic activity subject to tax. A broader tax base could result in additional tax revenue without rate changes.

Broader tax bases and lower tax rates tend to be more economically efficient than systems with narrow tax bases and high tax rates. While the rule holds in general, not all measures to broaden the tax base are sound tax policy. For instance, broadening the business tax base by lengthening depreciation schedules would cause significant economic harm.

Changing a tax rate is simple, but defining what should be subject to a tax is a complex and nuanced task that hinges on one’s view of an ideal tax base. Two primary approaches compete for this ideal: an income tax base and a consumption tax base.

Under an income tax base, individuals pay taxes on their consumption plus their change in wealth. Under a consumption tax base, individuals pay taxes only on their consumption.

To illustrate the difference between an income-based tax and a consumption-based tax, imagine a small business owner who earns $250,000 in net income, spends $200,000 of it on an investment, and consumes the remaining $50,000.

• Under an income-based tax, the business owner would pay taxes on both the $50,000 of consumption and the $200,000 increase in wealth.
• Under a consumption-based tax, the business owner would only pay taxes on the $50,000 of consumption and would not pay taxes on the investment until it yields a profit and is consumed in the future.

A consumption-based tax avoids double taxation of saving and investment, which otherwise imposes a higher effective tax rate on income saved and invested than income consumed immediately. For instance, in the example above, the income-based tax would apply to both the principal of the investment (the $200,000 spent today) and the profits of the investment (the profit that the investment would yield in the future). As a result, this double tax would make the business owner less likely to invest.

Income-based taxes often apply several layers of tax on the same investment. For instance, an individual’s investment in a US corporation may be subject to four layers of taxation: once when the income is initially earned, through the individual income tax; a second time when the corporation earns a profit, through the corporate income tax; a third time when the profit is distributed to shareholders, through the individual income tax on dividends; and a fourth time when the individual dies, through the estate tax.

Supporters of income-based taxes argue they are more progressive than consumption-based taxes. Because high-income taxpayers are more likely to save and invest than low-income taxpayers, placing several layers of taxes (or higher effective tax rates) on investment increases the tax burden on the wealthy. However, it is also possible to make consumption-based taxes progressive without imposing higher marginal tax rates on investment.

Under current law, the US tax system is a hybrid between a pure income-based tax and a pure consumption-based tax. For instance, capital gains are included in the tax base (income feature) but taxed at a lower rate (consumption feature). Another example: businesses are unable to deduct the full cost of their capital investments immediately (income feature), but the tax code allows for accelerated depreciation schedules and full expensing of some assets (consumption feature).

Some of the options in this book would move the US tax system further toward an income tax base, while others would move it further toward a consumption tax base. Lawmakers should consider which direction they wish to move toward and the trade-offs involved with each approach.

Economic Effects Matter Across Time Horizons

Tax cuts seldom pay for themselves, particularly in the context of the current US tax system, where marginal tax rates are much lower than they once were.

Economic growth can substantially offset a portion of the lost revenue from a tax cut (or can cost a portion of the additional revenue from a tax increase), but it depends on the type of tax change and timeline being considered.

Tax changes that have a more powerful effect on economic growth will produce relatively more “dynamic feedback” than tax changes with smaller economic effects. Dynamic feedback does not necessarily mean that the tax affected by the policy change raises additional revenue itself. For instance, a reduction in the corporate tax rate would reduce corporate tax revenue even after accounting for growth. Further, on a dynamic basis, we would generally expect corporate tax revenue to fall by a greater extent (if investment increases, corporate deductions will be larger). Offsetting effects would instead stem from individual income and payroll tax revenues increasing as demand for labor increases.

Dynamic effects can take time to materialize, depending on whether they affect labor supply or capital investment. Labor can respond relatively quickly to tax changes, and a change in the labor supply today changes output today. Capital can take longer to respond, as investments take time to permit, plan, place in service, and begin to produce output. Investments also continue to produce output for many years after they are placed in service.

This “adjustment path” means the ultimate economic effects of changes in the tax treatment of capital do not materialize immediately. In early years, the dynamic feedback of tax changes to capital may be smaller, but they grow over time. This trend can sometimes be seen in the 10-year window. But it is even more important beyond the 10-year window and is reflected in our measure of the debt-to-GDP ratio in 2056.

A particularly pro-growth tax cut policy might have a large deficit-increasing impact in the short term, but over the course of decades, it may mostly offset its fiscal impact with economic growth and therefore not materially harm the US’s long-term fiscal picture. Conversely, an economically harmful policy might reduce deficits in the short term, but it could reduce output enough to not materially improve the US’s long-term fiscal picture.

Caveats and Warnings

While the results capture important behavioral effects, including incentive effects of changes in marginal tax rates as well as some avoidance effects, the model does not capture all possible effects. For instance, the results do not capture the benefits of reduced compliance costs and other efficiencies of certain simplifying reforms, such as the repeal of estate and gift taxes, alternative minimum taxes for individuals and corporations, and other complex features of the code. Nor does it fully capture the tax planning and avoidance effects that may arise from novel policies, such as mark-to-market taxation. The model also assumes an open economy, such that taxes on US savers generally do not impact US economic output, a simplifying assumption that does not capture certain edge cases that may more closely resemble a closed economy.

Readers should not attempt to combine the revenue, economic, or distributional figures from multiple options. For instance, if Option A would raise $100 billion and Option B would raise $200 billion, it is not necessarily the case that implementing both Option A and Option B would raise $300 billion. The US tax system contains many components that interact with each other in complex ways.

If you are interested in assembling a tax plan of your own, please feel free to contact the Tax Foundation for assistance and model results at (202) 464-6200. Priority will be given to members of Congress and their staff.