vive la tax al qaeda: here's s one for the time capsule

"As a follow-up to the Tax Foundation’s recent assessment of the macroeconomic effects of Governor Mitt Romney’s tax plan, we now turn our attention to measuring the macroeconomic effects of President Barack Obama’s tax proposals.
The first part of this paper discusses the economic and distributional effects of the president’s proposals to sunset the Bush-era tax rates for high-income taxpayers. Next, we present the results of our modeling of the two largest tax increases in the Affordable Care Act (ACA), which will become effective in 2013. We then analyze the president’s corporate tax proposals as outlined in the White House’s Framework for Business Tax Reform.
The Economic Impact of Obama’s Individual Income and Estate Tax Plan
We modeled the following elements of the president's individual income and estate tax proposals, as presented in his 2012 Budget documents, in the following manner:

• Retain the Bush tax cuts for taxpayers in the bottom four tax brackets. This includes keeping the current marginal tax rate levels of 10 percent, 15 percent, 25 percent, and 28 percent, and keeping the capital gains and dividend rate caps of 0 percent for people in the 10 percent and 15 percent brackets, and 15 percent for people in the 25 percent and 28 percent brackets.
• Increase the marginal tax rates in the top two tax brackets from 33 percent to 36 percent and from 35 percent to 39.6 percent.[1]
• Increase the capital gains top rate to 20 percent and let the tax rate on dividends revert to 39.6 percent for people in the top two brackets.[2]
• Restore the phase-outs of personal exemptions and itemized deductions (the PEP and Pease provisions) for taxpayers with more than $250,000 in AGI (joint filers) and $200,000 (single filers). These typically raise the effective marginal tax rates by about 1 to 4 percent for families of various sizes while their incomes are in the phase-out range, above which rates return to the normal statutory levels.
• Increase the federal estate tax from the current 35 percent top rate with a $5 million exempt amount to the 2009 levels of a 45 percent top rate and a $3.5 million exempt amount.
  

The simulation was run separately for each provision and for all provisions combined. The results are shown in Table 1. Because of interactions, the separate effects do not necessarily add up to the total effect of all provisions.

The Model Results

We find that President Obama's income and estate tax rate increases fall heavily on the earnings of capital. Capital is the input most sensitive to tax. The higher proposed tax rates render much potential capital formation unaffordable. The capital stock and the economy would experience a reduction in growth as the least profitable capital is either squeezed out of existence or out of the country. The most serious consequence would be slower economic growth, less job creation, and less wage growth. Secondarily, the smaller income gains would reflect back on federal revenues, offsetting much of the revenue growth the president hopes to achieve with the tax increases. State and local budgets would be adversely affected as well.

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 (%)	-2.88%	-2.15%	-0.44%	-0.23%	-0.03%
Private business GDP (%)	-3.01%	-2.23%	-0.48%	-0.24%	-0.03%
Private business stocks (%)**	-7.46%	-5.81%	-0.99%	-0.65%	-0.07%
Wage rate (%)	-2.28%	-1.83%	-0.24%	-0.20%	-0.02%
Business hours worked (%)	-0.75%	-0.41%	-0.23%	-0.04%	-0.01%
Federal revenue (static est., $)	$136.1	$67.8	$37.3	$6.8	$19.1
Federal revenue (dynamic est., $)	$40.5	-$0.7	$23.1	-$0.4	$18.3
Federal spending ($)	-$14.9	-$11.6	-$1.9	-$1.3	-$0.1
Federal deficit (+ = lower deficit, $)	$55.5	$11.0	$25.0	$0.9	$18.4
% Dynamic revenue reflow vs. static est.***	-70.2%	-101.0%	-38.0%	-105.3%	-4.2%
GDP ($)	-$416.3	-$310.0	-$64.2	-$33.6	-$3.7
GDP/$ dynamic tax reduction****	-$10.27	N.A.	-$2.77	N.A.	-$0.20
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.

We estimate that President Obama's tax plan would gradually reduce the level of GDP by nearly 3 percent, relative to the baseline projection, over five to ten years. Labor income would be lower by a similar amount, driven down by fewer hours worked and lower wages per hour. The reduction in hours worked, about 0.75 percent, would be the equivalent of about a million jobs lost in today's economy, with those still employed earning roughly 2.28 percent lower wages. Alternatively, one could view the result as losing four million jobs at unchanged pay levels.
The plan would trim the capital stock by about 7.5 percent (or over $2 trillion in lost investment in plant, equipment, and buildings, things that drive productivity, wages, and hiring).
Three-quarters of the loss in GDP, labor income, and capital formation would come from the rise in the taxes on capital gains and dividends. These would trim GDP by a cumulative 2.2 percent over time, the capital stock by 5.8 percent, and the wage rate by 1.8 percent.[3] Though of smaller total magnitude, the estate tax increase is equally destructive per dollar of initial tax increase.
After all adjustments, fully 70 percent of the expected static revenue gain from President Obama’s plan would be lost due to the dynamic effects of slower economic growth. Revenue gains would be due entirely to the rise in the two top tax rates and the restoration of the PEP and Pease provisions.
Looking at the macroeconomic effects, the proposed increases in the top individual income tax rates would raise about 62 percent of their estimated static revenue gain. About 32 percent would be lost due to their contribution to a weaker economy, a 0.4 percent smaller GDP over the long run. PEP and Pease would lose less because of their weaker impact on production.[4]
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. (For more on capital gains, see below.)
The plan would lower the federal budget deficit by only about 40 percent of the estimated static revenue gains. There would be some saving in federal outlays due to lower economy-wide wages. Indeed, about a third of the net deficit decrease would be due to reduced wages and salaries of federal workers and lower costs of procurement. In the case of the capital gains and dividend tax rate hikes, which raise no revenue, all the reduction in the projected deficit is due to reduced federal wages and outlays. (Note, however, that the model does not cover the higher levels of Medicaid, welfare, and unemployment expenses. These items would tend to raise the deficit.)
Lawmakers should also be aware that each dollar of federal spending costs workers several dollars in lost wages and income from saving due to the economic damage from the taxes imposed. For the Obama tax plan as a whole, each $1 of increased government revenue it generates would reduce GDP by more than $10. Some elements of the Obama plan generate even higher costs to the public, reducing incomes and employment with no gain, and even some loss, to the federal budget.
The lower levels of capital, GDP, and income would take time to develop. It takes about five years to lose all of the additional equipment made unaffordable by the tax increases and about ten years for the full decline in the stock of structures to be achieved. About two thirds of the reductions in the capital stock would occur within five years. Job losses begin quite quickly, as fewer people are put to work producing machinery and buildings. The depression in employment and wages is sustained in the long term as workers must make do with the smaller amount of capital, and are left less productive on a permanent basis.

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	-6	2,606	0.01%	-2.95%
0 - 5,000	0	-75	0.00%	-2.73%
5,000 - 10,000	0	-212	0.00%	-2.64%
10,000 - 20,000	0	-410	0.00%	-2.62%
20,000 - 30,000	0	-665	0.00%	-2.70%
30,000 - 40,000	0	-917	0.00%	-2.76%
40,000 - 50,000	0	-1,148	0.00%	-2.71%
50,000 - 75,000	0	-1,566	0.00%	-2.72%
75,000 - 100,000	0	-2,200	0.00%	-2.73%
100,000 - 150,000	-1	-2,933	0.00%	-2.67%
150,000 - 200,000	-112	-3,837	-0.08%	-2.60%
200,000 - 250,000	-613	-5,161	-0.33%	-2.78%
250,000 - 500,000	-5,266	-11,670	-1.95%	-4.32%
500,000 - 1,000,000	-27,156	-39,941	-5.16%	-7.59%
> 1,000,000	-204,741	-269,723	-7.99%	-10.53%
TOTAL FOR ALL	-681	-1,983	-1.37%	-3.99%

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.

Impact of the Affordable Care Act Tax Increases

The ACA tax increases would further dampen economic activity. The most damaging is the additional 3.8 percent tax on income from savings and investment imposed on taxpayers with AGI in excess of $250,000 (joint returns) and $200,000 (single filers). It would raise the service price of capital and reduce investment. Also damaging would be the introduction of a second tax bracket on the HI (Medicare Part A) tax, adding 0.9 percent to the tax rate on wages and salaries in excess of the same thresholds. That tax would reduce hours worked and entrepreneurial activity.

Table 3: Economic and Budget Changes due to Obama Individual and Estate Tax Proposals and Pending HI and Savings Income Surtax Provisions of the Patient Protection and Affordable Care Act (PPACA)
Percent or dollar changes* in:	Combined	Tax Proposals	PPACA
GDP (%)	-4.10%	-2.88%	-1.23%
Private business GDP (%)	-4.28%	-3.01%	-1.28%
Capital stock (%)**	-10.57%	-7.46%	-3.29%
Wage rate (%)	-3.29%	-2.28%	-1.01%
Business hours worked (%)	-1.03%	-0.75%	-0.27%
Federal revenue (static est., $)	$199.9	$136.1	$63.8
Federal revenue (dynamic est., $)	$60.5	$40.5	$24.6
Federal spending ($)	-$21.4	-$14.9	-$6.5
Federal deficit (+ = lower deficit, $)	$81.9	$55.5	$31.1
% Dynamic revenue reflow vs. static est.***	-69.7%	-70.2%	-61.5%
GDP ($)	-$592.3	-$416.3	-$177.5
GDP/$tax dynamic reduction	-$9.79	-$10.27	-$7.23
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. *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.

Table 3 shows the separate and combined effects of the income tax and ACA tax increases on the economy. The ACA taxes would reduce economic output and labor income by an additional 1.3 percent, and would reduce the stock of capital by an additional 3.3 percent. The combined losses would be 4.1 percent of GDP and wages, and 10.6 percent for capital formation. Table 4 shows the distributional effects. After economic adjustments, all income groups would share in the income losses.

Table 4: Distribution of Income Effects of Obama Income and Estate Tax Proposals and PPACA Surtaxes on Wages and Investment Income
	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	-11	3,701	0.01%	-4.18%
0 - 5,000	0	-106	0.00%	-3.89%
5,000 - 10,000	0	-302	0.00%	-3.76%
10,000 - 20,000	0	-583	0.00%	-3.74%
20,000 - 30,000	0	-946	0.00%	-3.84%
30,000 - 40,000	0	-1,306	0.00%	-3.92%
40,000 - 50,000	0	-1,636	0.00%	-3.87%
50,000 - 75,000	0	-2,229	0.00%	-3.88%
75,000 - 100,000	0	-3,134	0.00%	-3.89%
100,000 - 150,000	-2	-4,175	0.00%	-3.79%
150,000 - 200,000	-116	-5,422	-0.08%	-3.68%
200,000 - 250,000	-1,145	-7,501	-0.62%	-4.04%
250,000 - 500,000	-9,959	-18,606	-3.69%	-6.90%
500,000 - 1,000,000	-40,218	-57,805	-7.64%	-10.98%
> 1,000,000	-294,775	-383,276	-11.50%	-14.96%
TOTAL FOR ALL	-1,016	-2,852	-2.05%	-5.74%

Assessing the President's Framework for Business Tax Reform

In February, the Obama administration presented a Framework for Business Tax Reform that envisioned lowering the corporate tax rate to 28 percent while staying revenue neutral by raising business income taxes in other ways.[5] This study cannot estimate the dynamic effects of the full Framework because, although the revenue raisers would probably have large negative effects, their magnitude can only be guessed at since the administration has not specified which ones would actually be in the package and has not provided details on how each would operate. (See below.)
Nonetheless, we offer the following estimate of the effect of including a reduction in the corporate tax rate to 28 percent if it were enacted without the revenue offsets suggested in the Framework—that is, if it were a straightforward tax cut. This is the most generous treatment we can give the President's proposals inclusive of the business tax reform.

Table 5: Comparison of the Economic and Budget Effects of Obama Tax Proposals With and Without Business Tax Reform
Percent or dollar changes* in:	Obama Individual (a)	Obama indiv. & corp. (b)	Cut Corporate Rate to 28% (c)
GDP (%)	-2.9%	-1.3%	1.6%
Private business GDP (%)	-3.0%	-1.4%	1.7%
Capital stock (%)**	-7.5%	-3.3%	4.5%
Wage rate (%)	-2.3%	-0.9%	1.4%
Business hours worked (%)	-0.7%	-0.4%	0.3%
Federal revenue (static est., $)	$136	$100	-$36
Federal revenue (dynamic est., $)	$41	$57	$14
Federal spending ($)	-$15	-$6	$9
Deficit (+ = reduction, - = increase, $)	$55	$63	$5
% Dynamic revenue reflow vs. static est.***	-70%	-43%	139%
GDP ($)	-$416	-$188	$233
GDP / $ dynamic tax change****	-$10.27	-$3.32	N.A.
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. (a) The first Obama column displays effects of his proposed increases in individual and estate taxes as presented in the 2012 Federal Budget. (b) The second Obama column includes the reduction in the corporate tax rate to 28% proposed in the February White House/Treasury Framework For Business Tax Reform, but without the suggested revenue offsets. The offsets, if enacted, would negate the bulk of these benefits from the rate cut. The corprate tax eventually recovers its static revenue cost due to added growth. The economy and the budget would be better served by omitting the offsets. (c) The effect of the cut in the corporate rate by itself. *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. in the last column indicates that the corporate tax rate cut, by itself, would actually gain revenue due to its positive effects on the economy.

The corporate rate cut would add over 1.6 percent to the GDP and recover its static revenue loss with room to spare. It would reduce the economic damage from the president's individual and estate tax proposals by about 56 percent, while increasing revenues and providing a larger reduction in the deficit. GDP would fall by 1.3 percent off the baseline instead of nearly 3 percent. The deficit would be reduced by $63 billion instead of $55 billion.[6]
The irony is that if the president had merely offered to reduce the corporate tax rate to 28 percent without the offsets and without insisting on revenue neutrality, his plan would have recovered most if not all of the lost revenue. By restricting the offsets to increases in the taxes on capital formation, he ensures that the reform will achieve nothing. A look at the proposed offsets explains why.
The administration has offered a long menu of potential revenue raisers and described them only in general terms. While the lower corporate rate would encourage business investment and entrepreneurial activity, which would positively impact tax revenue, many of the business tax increases on the administration's menu would have negative feedbacks.
The Framework insists that the proposals be at least revenue neutral. Indeed, they suggest that certain expiring tax provisions that have been renewed on a temporary basis for some years (such as the R&D tax credit) should be paid for this time around, suggesting a possible $250 billion tax increase. It is very hard to imagine how a static revenue-neutral tax change on capital formation can reduce the cost of adding to the capital stock and improve the economy, let alone a tax increase.
Consider three of the possible business tax increases. Noting that many forms of businesses organization, such as S corporations, partnerships, and sole proprietorships, are not subject to the corporate income tax (income from those businesses is immediately passed through to owners' tax forms, where it is subject to the individual income tax), the administration suggests imposing both the corporate income tax and the individual income tax on some pass-through income. That would certainly broaden the corporate income tax base, but subjecting more business income to two separate income taxes would raise the cost of capital and discourage business activity. It would take a larger reduction in the corporate and individual tax rates than the administration has offered to offset that sort of base broadening.
Another option is not allowing businesses to deduct all their interest costs. That would expand the income tax base by forcing some businesses to understate their expenses and, thereby, overstate their income. That would hurt business activity by raising the cost of debt-financed investment. Business people would demand a higher minimum pretax return before undertaking new business investments in order to compensate for having to pay income tax on phantom income.
A third possibility on the administration's long list is heavier taxation of oil and gas producers and royalty owners, coupled with tax incentives for clean energy. Oil and gas production has been one of the few genuinely bright spots for the U.S. economy in recent years, as people in petroleum producing states like North Dakota can attest. Meanwhile, heavily government-subsidized clean energy projects have been plagued by unmet technological promises, broken job-creation promises, bankruptcies, and charges of government-business cronyism. Forcing capital to move from the development of profitable, traditional energy sources to uneconomical alternative energy sources is value-destroying, not value-adding.
More information would be needed from the administration in order to estimate whether the net impact of the statutory corporate rate cut and the offsetting business tax hikes would be negative, a wash, or positive. We suspect that the outcome would be negative.
Previous Increases in the Taxation of Capital Prove Harmful
Many types of tax changes move revenues in the normal direction predicted by static analysis. Tax rate increases raise revenues; tax rate reductions reduce revenues. They do not alter economic growth and incomes enough to completely offset their projected revenue gains or losses. For example, across-the-board income tax rate reductions recover only about a third of their static revenue losses with additional growth (while adding more than $2 to people’s pre-tax incomes for each dollar of revenue loss to the government). Likewise, excise taxes, sales taxes, and payroll taxes are generally not over the revenue-maximizing hump of the Laffer curve.
Nonetheless, some tax reductions (or increases) are unusually effective in raising (lowering) incomes and recovering (losing) revenues. Capital formation is highly sensitive to after-tax earnings. Some tax changes that aim directly at capital formation can trigger enough of a change in the stock of buildings, the amount of equipment, and the hiring of workers to utilize them to come close to, or even more than offset, the initial revenue change. These include reductions in the estate tax and steps that offset some of the double taxation of corporate income, including lower corporate tax rates and lower taxes on capital gains (which hit retained after-tax corporate earnings) and dividends (which are paid out of after-tax corporate earnings). Raising these taxes can often be entirely counter-productive.
One must count revenue from all sources to determine the revenue effect of a particular tax change. For instance, a modestly higher tax rate in the top two tax brackets would probably raise revenue from those taxpayers, although not as much as the static revenue estimates would suggest. (That might not be the case if the rate increases were truly outrageous, as with the recent French rate hike to 75 percent, and if the U.S. were a relatively small nation in a larger economic community to which the afflicted minority could readily flee.) However, the higher tax rates of top earning savers and investors would reduce capital formation and hiring, and would lower wages across-the-board. Federal revenues from payroll and income taxes, corporate taxes, excise taxes, and tariffs would fall as well, adding to the total revenue offset. State and local governments would see as drop in their sales and income tax receipts.
By contrast, the lowering of the capital gains tax rate in 1978, 1981, and 1997 may not only have raised incomes and general revenues, it may also have raised revenues from the capital gains tax itself. The then-existing rates were above the revenue maximizing capital gains tax rate, which appears to be a bit under 10 percent (looking only at capital gains revenues).[7] The reduced rate raised the value of capital (boosting the amount of gains to be reported) and encouraged people to take gains earlier than otherwise. Such a rate cut is one of the few cases where the tax’s own revenue may rise with a rate cut.
In the other direction, the increase in the capital gains tax rate in the Tax Reform Act of 1986 resulted in a sharp collapse in realizations. Revenues from the tax plunged both in dollars and as a share of GDP. They did not regain their share of GDP until the rate was reduced again in 1997. That is not counting the damage done to capital formation and other revenues. In the Obama plan, the proposed increase in the rate to 20 percent for the top brackets would reduce capital gains collections due to reduced realizations. It would also lower the value of assets, cutting the amount of gains available to be taken. We do not model these effects. They would be in addition to the reduction in other revenues due to reduced economic activity and income, which we do model.
The 1986 Tax Reform Act was designed to be revenue neutral, with many base broadeners that raised taxes on capital income. These base broadeners offset the benefits of the reduction in the corporate tax rate. Taxes on capital income rose to pay for the lower tax rates on labor income and to provide tax credits to address social issues. The result was a slower rate of economic growth in the last third of the decade, damaging revenue collections from many sources in addition to the collapse in tax revenues from capital gains.

Conclusion

Tax Foundation economists measured the economic and distributional effects of all of President Obama’s tax proposals: his plan to sunset the Bush-era tax rates for high-income taxpayers; his corporate tax plan; and, the tax changes contained in the Affordable Care Act beginning in 2013. We found that these proposals would lower economic growth while substantially lowering workers’ wages and incomes. Ultimately, these tax plans would be very harmful for the nation’s long-term economic outlook.

Appendix

The Model

The model is keyed to 2008 levels of income and GDP to utilize an actual set of tax and economic data for the baseline and to produce a picture of the likely effects once we are past the statistical distortions of the recent recession. This model produces a simulation of what the policy change would do to the economy, incomes, and tax revenues after all economic adjustments are given time to work, which is roughly five to ten years. It does not show the annual progression, year by year, from the starting point to the final outcome, but most of the effects occur within five years.
The model is neo-classical; its projections are derived from tax-driven changes in the quantity of capital and labor offered to the market and used to produce output within the United States. They do not include any additional behavior changes to avoid the higher taxes, such as a slowdown in the rate of realization of capital gains or reductions in dividend payments, nor any reduction in R&D or the rate of technological advance as a result of the initial reduction in the after-tax returns to investment.[8]

---

[1] The top brackets for taxable income currently kick in at approximately the President's proposed thresholds of $250,000 in adjusted gross income for joint filers and $200,000 for single filers, at typical levels of itemized deductions. The equivalent dollar amounts for these brackets were lower in 2008 and were run at those levels.
[2] This was approximated by letting both rates rise to 24 percent, which is the weighted average of the two rates given the relative amounts of each realized in the base year.
[3] To be clear, these percentage changes in GDP (and other variables) are the long run differences between the level of GDP in the baseline and the level the GDP will be at after all adjustments to the tax change are completed, about five years for equipment and ten years for buildings and other structures. They are not increases or decreases in the annual rate of growth of the variables. Thus, if the GDP is shown ultimately to be reduced by 2.9 percent by the policy change, the rate of growth of GDP would average about a quarter percentage point slower for about a decade (a bit more in the first half, a bit less in the second half) to build up to the final differential. Once the labor force and capital stock have finished their decline relative to the baseline, annual growth rates would presumably return to normal, but from a lower base.
[4] The adverse incentive effect of PEP and Pease is limited to the range of income over which the exemptions and deductions are phased out. Once a taxpayer has lost all personal exemptions and the full 80 percent of itemized deductions subject to phase-out, his or her effective marginal tax rate reverts to normal levels. Much of the income at these levels exceeds the phase-out ranges.
[5]The White House & Department of the Treasury, The President's Framework for Business Tax Reform (Feb. 2012), http://www.treasury.gov/resource-center/tax-policy/Documents/The-Presidents-Framework-for-Business-Tax-Reform-02-22-2012.pdf.
[6] The model overstates the impact of corporate tax rate changes and understates the impact of individual tax rate changes due to the inclusion in the corporate sector of the so-called pass-through entities. In the context of the Obama tax plan, it understates the damage done by the individual tax provisions and overstates the offsetting benefits available from reducing the corporate tax rate. The model uses capital stock data provided by the Bureau of Economic Analysis. BEA combines capital stock and other data for all corporations, lumping together C corporations, S corporations, REITs, and RICs. Only the C corporations are subject to the additional corporate tax rate. The rest are pass-through entities whose earnings are subject only to the individual income tax. The model captures the individual income taxes imposed on the pass-through income, but its service price changes, weighted by the capital stock, are too large in the corporate sector and too small in the non-corporate sector. The pass-throughs have grown as a share of the economy and need to be modeled explicitly. The BEA expects to devote some resources to splitting the pass-through data from the C corporation data in 2014.
[7] Paul Evans, The Relationship between Realized Capital Gains and Their Marginal Rate of Taxation, 1976-2004, IRET Dynamic Tax Analysis Series: Capital Gains (Oct. 9, 2009), http://iret.org/pub/CapitalGains-2.pdf.
[8] The model is described in more detail in our paper on the Romney tax proposals. See Stephen Entin & William McBride, Simulating the Economic Effects of Romney's Tax Plan, Tax Foundation Fiscal Fact No. 330 (Oct. 3, 2012), http://taxfoundation.org/article/simulating-economic-effects-romneys-tax-plan."

------------------------------------------------

part deux


"The debate over Mitt Romney’s tax plan has largely revolved around the short term concerns of who gets what and how much, rather than the more long term concerns of economic growth, job creation, deficit reduction, and tax reform.[1] This is unfortunate, especially in a time of record unemployment and debt levels. These serious issues have been put aside to focus particularly on the results of a single study by the Tax Policy Center (TPC),[2] which finds Romney’s tax plan would require raising taxes on low- and middle-income earners to pay for tax cuts for high-income earners. However, to get there, TPC assumes that tax rates do not matter for economic growth, i.e., Romney’s plan to cut income tax rates by 20 percent across the board will have no effect on labor supply or saving and investment decisions. Only among Washington score keepers does such an assumption make sense, but it certainly has no credibility among academic economists.[3]
Economists recognize that there is more to a tax cut than the immediate increase in wealth of the recipient. There is a change in incentives because there is a change in the law. If investment taxes are lowered, investment increases, because investors expect to keep more of their after-tax returns, and more people become investors. If taxes on wages are lowered, more people work and more people work harder. The benefits from these things spill over beyond the immediate actors. Businesses invest in equipment and new hires, leading to more productive workers, higher wages, and ultimately satisfied customers. If this is “trickle down” economics, as the president contends,[4] this is also economics according to every major textbook and treatise since Adam Smith.[5]
Certainly, economists disagree about the degree to which taxes affect behavior, but they will all admit that zero effect is not realistic. So, in an effort to produce a more realistic assessment of Romney’s tax plan, we have simulated the effects using a model built on a standard neo-classical growth model found in virtually all textbook treatments.
The results are considerably different from TPC’s. We find that fully 60 percent of the static revenue loss from Romney’s plan is recovered when the dynamic effects of economic growth are taken into account. We find that while the cuts in the individual income tax rates do not “pay for themselves,” they do grow the economy 1.8 percent over the long run. The biggest boost to the economy comes from the 10 point cut in the corporate rate, which grows GDP by 2.3 percent, the capital stock by 6.3 percent, and the wage rate by 1.9 percent. The corporate rate cut is so economically beneficial that it does pay for itself, when all federal revenue effects are considered. So does the elimination of taxes on capital gains and dividends for middle-income earners and the estate tax.
These benefits are widely shared. Every income group experiences at least a 7 percent increase in after-tax income.

The Model

Key elements of the Romney tax plan were analyzed using a tax calculator and economic model, which is described in more detail in the Appendix. The model is keyed to 2008 levels of income and GDP to utilize an actual set of tax and economic data for the baseline and to produce a picture of the likely effects once we are past the statistical distortions of the recent recession. This model produces a simulation of what the policy change would do to the economy, incomes, and tax revenues after all economic adjustments are given time to work, which is roughly 5 to 10 years. It does not show the annual progression, year by year, from the starting point to the final outcome, but most of the effects occur within 5 years.
The following portions of the Romney tax plan were modeled, which are the specified tax rate cuts but not the unspecified base-broadeners (closing of various tax preferences, such as credits and deductions):

1. A 20 percent reduction in individual marginal income tax rates in all brackets.
2. Elimination of tax on capital gains and dividends for lower and middle income tax taxpayers. (The tax on these items was zeroed out in the bottom four brackets, which roughly match the income thresholds suggested in the Romney tax proposal. This somewhat overstates the tax relief for the fourth income tax bracket for single filers, but is very close to the thresholds in the Romney plan for married couples and heads of households. Due to time constraints, we did not model the proposal to eliminate tax on interest income in the same brackets.)
3. Elimination of the alternative minimum tax (AMT).
4. Reduction of the corporate income tax rate from 35 percent to 25 percent.
5. Elimination of the federal estate tax. (We kept the gift tax, as does the Romney plan, and retained the step-up in basis at death; ending step-up would reduce the effective tax cut on capital formation, dampen growth, and actually lose revenue compared to retaining step-up.)

The simulation was run separately for each provision and for all provisions combined. The results are shown in Table 1. Because of interactions, the separate effects do not necessarily add up to the total effect of all provisions.

Economic Consequences of the Tax Plan

The Romney plan would raise actual and potential GDP by about 7.4 percent over a five to ten year adjustment period. The private business sector would grow about 7.8 percent. About two-thirds of the growth in GDP would go to labor income, across the board, in the form of more hours worked and higher wages per hour. Total labor compensation in the private business sector would rise by 7.8 percent in line with GDP. About a third of the gain, pre-tax, would accrue to savers and investors. The plan would boost the capital stock by about 18.6 percent (over $5 trillion in additional investment), which is what drives the increase in productivity, wages, and hiring.

The reduction in the corporate tax rate yields the largest improvement in GDP and wages, followed by the 20 percent reduction in individual tax rates and the elimination of the capital gains and dividend taxes on middle income taxpayers. However, relative to the static revenue loss, the biggest bang for the buck comes from the capital gains and dividend relief, followed by the corporate rate reduction and the elimination of the estate tax.

Table 1: Effects of the Romney Tax Plan on the Economy and Budget
	All Tax Provisions	Corporate Income Tax Cut	Individual Income Tax Cut	End AMT	Capital Gains and Dividends Tax Cut	End Estate Tax
GDP	7.4%	2.3%	1.8%	0.1%	1.6%	0.9%
Private business GDP	7.8%	2.3%	2.0%	0.1%	1.6%	0.9%
Capital stock	18.6%	6.3%	3.2%	0.3%	4.4%	2.5%
Wage rate	4.7%	1.9%	0.5%	0.1%	1.3%	0.8%
Hours worked	3.0%	0.4%	1.5%	0.1%	0.3%	0.2%
Federal revenue	-$137.4	$19.1	-$113.7	-$18.1	$15.3	$1.9
Federal expenditure	$34.1	$12.2	$5.9	$0.5	$8.5	$4.8
Federal deficit	-$171.4	$6.9	-$119.6	-$18.6	$6.8	-$2.9
Static revenue	-$338.3	-$51.6	-$168.0	-$22.4	-$33.6	-$25.4
Dynamic revenue	-$137.4	$19.1	-$113.7	-$18.1	$15.3	$1.9
% Revenue Reflow	59.6%	136.9%	32.3%	19.4%	145.6%	107.4%
$GDP	$1,066.7	$325.6	$266.7	$19.7	$228.4	$128.2
$GDP/$tax reduction.*	$7.77	N.A.	$2.35	$1.09	N.A.	N.A.
Note: All dollar figures are in billions. 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. * Positive numbers indicate that the government would lose revenue with this tax cut, but that economic output (GDP) and people's pretax incomes would rise by the indicated amount for each dollar of revenue lost. N.A. indicates that the tax cut would actually raise revenue due to the economic benefit it provides, and that GDP and people’s pre-tax incomes would rise with no cost ( and some benefit) to the federal budget. **Erratum: Some figures in this column have been slightly amended since this paper was first published to correct for the inadvertent inclusion of the old PEP and Pease provisions in the 2008 baseline. The Tax Foundation regrets the error.

Gains in After-Tax Income are Across-the-board

Regardless of the initial distribution of a tax change, the economic reactions to a tax reduction distribute the economic gains (or losses in the event of a tax increase) across the board. Tax reductions on capital formation help labor by increasing productivity, wages, and employment. Tax increases on capital reduce productivity, wages, and employment. The differences between the static and dynamic consequences of the Romney tax package are displayed below. They are shown before any base broadening to trim the size of the upper income tax reductions to pay for the residual cost of the tax cuts.
The static changes in after-tax income are due solely to the average initial tax cut per tax return in each income class. The dynamic increases in after-tax income are the sum of the tax cut plus the projected increase in income due to the improvement in the economy (which will also affect the tax due to the government). Low-income taxpayers (those earning less than $50,000) are shown to receive a roughly $200 to $3,500 increase in after-tax income as a result of the tax program, on a dynamic basis, even though these filers paid little tax initially and received small initial tax cuts on a static basis. For them, nearly all the gains in income are due to a stronger economy and higher wages and hours worked.

Table 2: Distribution of Income Effects*
	Average per Return (2008 dollars)		Percent Changes
	Static	Dynamic	Static	Dynamic
Adjusted Gross Income Class (2008 dollars)	After-Tax Income	After-Tax Income	After-Tax Income	After-Tax Income
< 0	131	-6,845	-0.15%	7.74%
0 - 5,000	0	190	0.02%	6.94%
5,000 - 10,000	7	551	0.09%	6.84%
10,000 - 20,000	54	1,110	0.35%	7.11%
20,000 - 30,000	174	1,897	0.71%	7.70%
30,000 - 40,000	349	2,730	1.05%	8.20%
40,000 - 50,000	531	3,526	1.26%	8.34%
50,000 - 75,000	855	4,969	1.49%	8.64%
75,000 - 100,000	1,277	7,045	1.58%	8.73%
100,000 - 150,000	2,471	10,310	2.25%	9.37%
150,000 - 200,000	6,267	16,644	4.25%	11.30%
200,000 - 250,000	10,583	23,586	5.70%	12.70%
250,000 - 500,000	18,734	37,784	6.94%	14.00%
500,000 - 1,000,000	33,119	71,765	6.29%	13.64%
> 1,000,000	121,859	318,331	4.76%	12.42%
TOTAL FOR ALL	1,375	4,923	2.77%	9.91%
*Erratum: Some figures in this table have been slightly amended since this paper was first published to correct for the inadvertent inclusion of the old PEP and Pease provisions in the 2008 baseline. The Tax Foundation regrets the error.

Budget Consequences of the Tax Plan

The Romney tax plan would recover nearly 60 percent of the static projected revenue cost due to economic growth, higher wages and employment, and higher tax collections on the higher incomes. To keep the reform revenue neutral, the government would only need base-broadeners equal to about 40 percent of the static cost.[6]
People need to be aware that each dollar of federal spending costs them several dollars in lost wages and income from saving due to the economic damage from the taxes imposed. In the case of the Romney tax plan, each $1 of lost government revenue would raise incomes by nearly $8. Would the public be willing to trade a $1 reduction in government spending for an additional $8 in personal income? Some elements of the Romney plan yield even higher benefits to the public, raising incomes and employment with no cost, and some benefit, to the federal budget, and actually help to pay for the other tax reductions.
Nearly all the tax reductions in the Romney plan would have some positive economic results, which would raise incomes and thereby recover some of the lost tax revenue. Most tax reductions do not completely “pay for themselves” with higher revenue, but they do add to economic growth and incomes, creating a significant net benefit to the public. For example, the across-the-board income tax rate reductions and elimination of the AMT recover only about 32 percent and 19 percent of their static revenue losses, but add $2.35 and $1.09 respectively to people’s pre-tax incomes for each dollar of revenue loss to the government (raising after-tax incomes by the economic gains plus the tax cut).
Nonetheless, some tax reductions are unusually effective in raising incomes and recovering revenues. Capital formation is highly sensitive to after-tax earnings. Some tax changes that aim directly at capital formation can trigger enough additional plant building, equipment purchasing, and hiring to come close to, or even more than offset, the initial revenue reduction. These include reductions in the estate tax and steps that offset some of the double taxation of corporate income, including lower corporate tax rates and lower taxes on capital gains (which hit retained after-tax corporate earnings) and dividends (which are paid out of after-tax corporate earnings). Our results indicate that these tax cuts do pay for themselves, meaning they benefit the federal government and the rest of the economy, including federal income taxpayers, low-income people who owe no federal taxes, and state and local governments.
One must count revenue from all sources to determine the revenue effect of a particular tax change. For instance, a lower corporate tax rate does not usually raise corporate tax revenue. Rather, it encourages the creation and use of a larger amount of plants, equipment, commercial buildings, and rental housing in the United States. This added physical capital boosts productivity, wages, and employment, which results in added personal income and additional tax revenue from the higher incomes and payroll. Federal excise taxes and tariffs also rise with the added growth in income and consumption. State and local governments benefit from higher sales and income tax receipts which help their budgets as well.
By contrast, the lowering of the capital gains tax rate in 1978, 1981, and 1997 may not only have raised incomes and general revenues, it may also have raised revenues from the capital gains tax itself. The then-existing rates were above the revenue maximizing capital gains tax rate, which appears to be a bit under 10 percent (looking only at capital gains revenues).[7] The reduced rate raised the value of capital (boosting the amount of gains to be reported) and encouraged people to take gains earlier than otherwise. Such a rate cut is one of the few cases where the tax’s own revenue may rise with a rate cut. In the Romney plan, the rate cut to zero for the middle brackets would reduce capital gains collections but raise other revenues due to increased economic activity and income. Counting all types of income and tax revenue, the globally revenue maximizing capital gains rate is probably zero.

Previous Pro-growth Policies Proved that “Yes We Can”

At the present time, the economy is about 12 percent below its long term growth trend. There is no doubt that the economy has the “room” to expand an additional 7 or 8 percent over the next decade as the result of pro-growth tax reductions. History gives several examples of similar growth following similar tax changes.
The Romney tax plan is very nearly as powerful as the Kennedy tax cuts that were phased in between 1962 and 1965. The Romney plan is as strong in lowering the service price of capital, mainly due to its 10 percentage point cut in the corporate tax rate. The Kennedy cuts included a four point reduction in the corporate tax rate, a 7 percent investment tax credit, and faster depreciation write-offs. The Romney plan’s 20 percent across-the-board individual cuts are of the same pattern as the roughly 20 percent across-the-board Kennedy individual income tax rate cuts. The Kennedy tax cuts were not paid for with tax offsets (base broadeners) but were accompanied by some spending reductions. The economy surged following the Kennedy cuts, “broadening” the tax base through economic growth and employment gains, which is the best kind of base broadener there is. The federal deficit was significantly lower in 1965 ($1.4 billion) than in 1961 ($3.3 billion) before the tax cuts began to take effect.
By contrast, the Johnson 10 percent Vietnam War surtax on individual and corporate income between 1968 and 1970 helped to trigger the 1969-1970 recession. The deficit fell but at a steep price in lost jobs and falling incomes.
The Romney plan is about two-thirds as powerful with respect to capital formation as the 1981 Economic Recovery Tax Act under President Reagan (although a portion of that Act was repealed in 1982 and 1984 before it became fully effective). The 1981 Reagan tax cuts were phased in slowly, but by 1983 they had begun to generate a very strong economic recovery, broadening the tax base through economic growth and rapid job creation.
By contrast, the 1986 Tax Reform Act was designed to be “revenue neutral,” with many “base broadeners” that raised taxes on capital income. These “base broadeners” offset the benefits of the reduction in the corporate tax rate. Taxes on capital income rose to pay for the lower tax rates on labor income and to provide tax credits to address social issues. The result was a slower rate of economic growth in the last third of the decade and a collapse in tax revenues from capital gains.
The 2003 tax cut under George W. Bush produced the largest cut in the service price of capital since the 1981 tax cut. It turned a lackluster recovery into a strong expansion. Although it raised the deficit from $158 billion in 2002 to $412 billion in 2004, the subsequent economic expansion reduced the deficit to $161 billion in 2007.

Revenue Neutral or Budget Neutral? Which Helps the People the Most?

Tax reform should be about increasing jobs and raising incomes and living standards, not just about closing the budget gap. This is not just an inside-the-Beltway numbers exercise, and it is not about making the budget process easier or more convenient for Congress and the White House.
If the plan were made budget neutral instead of revenue neutral, the revenue shortfall could be covered by reductions on the spending side of the budget, including “corporate welfare” subsidies or reductions in low value federal projects.

Transition Issues

The higher levels of capital, GDP, and income take time to develop. It takes about 5 years to acquire all of the additional equipment made possible by the tax reductions and about 10 years for the additional structures to be completed. About two-thirds of the expansion of the capital stock occurs within 5 years. Job growth begins quite quickly, as people are put to work creating the additional machines and buildings. Job growth continues and is sustained as people are then put to work using the additional machinery and industrial and agricultural structures, and working and shopping in the additional commercial buildings.
The revenue recovery from the expansion takes time to develop. The greatest budget hit from the tax reductions occurs in the early years. A temporary injection of revenue or spending restraint should supplement the tax cuts. An obvious candidate would be one-time asset sales and elimination of recent increases in federal outlays for emergency “stimulus” that will not be needed as the economy picks up. Other budget changes that would enhance economic growth, as well as help fund the pro-growth tax reform, could include reductions in the least valuable federal spending programs, including numerous subsidies of uneconomical private industries.

Asset Sales

The federal government possesses an enormous asset portfolio. It estimates that, at the end of fiscal year 2011, it held approximately $1,400 billion of equipment and structures, $300 billion of inventories, $940 billion of land, and $480 billion of mineral rights.[8] The Federal Government owns approximately 28 percent of the land in the United States.[9] Many of these assets are not needed for federal operations, and many are poorly managed. Selling a portion of the government's asset holdings would have the dual advantages of allowing the nation's resources to be used more efficiently and helping finance the temporarily high costs of tax reform in the early years before the positive growth effects kick in. The federal government could realize additional income, as well as reduce its yearly spending, by privatizing some of the enterprises it now owns and operates.[10] Asset sales and privatization have been powerful financing tools for many foreign nations.[11]

Spending Restraint, Short and Long Term

The CATO Institute has identified what it considers to be “corporate welfare” outlays in the federal budget.[12] These total some $97 billion dollars at projected 2012 budget outlays. They include $25 billion in the Department of Agriculture, $4 billion in economic development and trade in the Department of Commerce, $5 billion in R&D subsidies in the Department of Defense, $17 billion in the Department of Energy, $16 billion in HUD, and $29 billion in other departments and agencies. Eliminating roughly a third of these outlays could offset about a quarter of the long-run dynamic cost of the tax plan, adjusting for the difference in base years.

Capping Tax Expenditures for the Long Term

The TPC study insists on revenue neutrality rather than budget neutrality in its analysis of the Romney tax plan, and does its arithmetic on the assumption of a static economic baseline. It restricts its offsets to the cost of the reduction to base broadeners chosen from the Income Tax Expenditures list in the Federal Budget. If on a dynamic basis the necessary offsets are only 40 percent of the amounts assumed using the TPC static economic analysis, the job becomes much simpler.
For example, the largest tax expenditure, as of the 2008 budget, was the exclusion of employer provided health insurance and health care, estimated at $160 billion. The static revenue loss from the tax cut ($336 billion) is more than twice that amount. The dynamic revenue loss from the tax cut ($136 billion) is only 85 percent of that amount. If we capped the exclusion for upper income taxpayers to trim a fifth of the cost ($36 billion), it would pay for more than a quarter of the dynamic long term revenue loss.
One of the major subsidies to states in the tax code is the exclusion of tax on public purpose state and local bonds, amounting to $27 billion in 2008 and used mainly by upper income taxpayers. Eliminating that would cover nearly 20 percent of the dynamic revenue loss. Other tax expenditures considered by TPC, such as deductibility of state and local property taxes ($13 billion) and mortgage interest ($89 billion) on owner-occupied homes, and state and local income and sales taxes ($28 billion), all of which are currently limited by the AMT, might be capped. Taking a fifth of each, from the upper income, would provide $26 billion at 2008 levels, another 20 percent of the dynamic cost of the tax cuts.
The deduction of income from domestic production (often called the “manufacturers’ credit”) would probably be repealed as part of business and personal tax rate reductions. That is valued at $14 billion for 2008. However, that would dampen the expansion of capital formation by reducing returns to investment.
These items would cover about three-quarters of the long run dynamic cost of the Romney plan. As noted above, corporate welfare reductions could cover the remainder. We do not necessarily endorse these specific tax expenditure changes as our first preference and would prefer more spending restraint. We merely offer them as evidence that one does not need to attack the middle income tax expenditures, nor offset the middle income tax cuts, to pay for the Romney tax reductions.

Conclusion

While the debate over tax reform has been consumed with distributional issues, the economy continues to limp along in the worst recovery since the Great Depression. To be sure, this economy faces headwinds that even an ideal tax code will not address, but pro-growth tax reform can provide substantial benefits. Our results indicate that by lowering tax rates on investment and labor, the Romney tax plan would grow the economy by 7.4 percent, the capital stock by almost 19 percent, wages by almost 5 percent, and hours worked by 3 percent. The benefits would be widely enjoyed, as every income group would experience at least a 7 percent increase in after-tax income. It would benefit the federal budget as well, in that fully 60 percent of the static revenue loss from Romney’s plan would be recovered from taxing a larger economy.

Appendix: More on the Model

The study takes a neo-classical view of the economy, in which decisions about work, saving, and capital formation are driven by the after-tax rewards for these activities. The taxes that affect these decisions are the marginal tax rates on additional effort. They alter the choices between capital formation and consumption, and between labor and leisure.
Specifically, we looked at the changes to the marginal tax rates on labor income, weighted by the incomes of the earners. The income weights reflect the productivity of the workers; a worker earning $20,000 a year working 2,000 hours will add $10 to GDP by working an extra hour. A worker earning $200,000 a year would add $100 to the GDP by working an extra hour. The marginal rate changes were found by using a tax calculator that is based on the impact of the tax changes on a large sample of tax returns from the IRS Statistics of Income Public Use File.
We also calculated the changes in the income‑weighted marginal tax rates on dividends, capital gains, and non‑corporate business income, as well as the corporate income tax rate, the estate and gift tax, and the depreciation schedules. These were used to determine the effect of the policies on the "service price" of capital. The service price is the rate of return that capital must earn to cover its economic obsolescence, pay taxes, and yield a normal after‑tax return to the owners. A higher service price forces a reduction in the capital stock, eliminating capital that cannot earn enough to clear the hurdle rate of return. A lower service price encourages additional capital formation.
The changes in these two tax "wedges" were then entered into an economic model using a Cobb‑Douglas production function and a labor supply curve. The model determined the increase or decrease in the supply and employment of labor and the size of the desired capital stock and the resulting changes in GDP and incomes. The effect of the income changes was allowed to feed back into the tax rates, which resulted in further income adjustments, until a new equilibrium was reached. The production function is described in greater detail in Stephen J. Entin, Economic Consequences of the Tax Policies of the Kennedy and Johnson Administrations, IRET Policy Bulletin No. 99 (Sept. 6, 2011), Appendix A, available at http://iret.org/pub/BLTN-99.PDF.

---

[1] William McBride, Romney, Obama, & Simpson-Bowles: How Do the Tax Reform Plans Stack Up?, Tax Foundation Fiscal Fact No. 327 (Sept. 6, 2012), http://taxfoundation.org/article/romney-obama-simpson-bowles-how-do-tax-reform-plans-stack.
[2] Samuel Brown, William Gale, & Adam Looney, On the Distributional Effects of Base-broadening Income Tax Reform, Urban-Brookings Tax Policy Center (Aug. 1, 2012).
[3] Harvey Rosen, Growth, Distribution, and Tax Reform: Thoughts on the Romney Proposal (Working Paper No. 228, Princeton University, Sept. 2012), http://www.princeton.edu/ceps/workingpapers/228rosen.pdf.
[4] Rick Pearson & Monique Garcia, Obama: GOP economic plan ‘trickle-down fairy dust’, Chicago Tribune, Aug. 12, 2012, http://www.chicagotribune.com/news/local/breaking/chi-five-fundraisers-on-tap-for-obama-in-chicago-today-20120812,0,6859587.story.
[5] See Thomas Sowell on the history of “trickle down” rhetoric, and how there never was a theory behind it, only a caricature: http://www.tsowell.com/images/Hoover%20Proof.pdf.
[6] This assumes that the base-broadeners are designed so as not to offset the growth incentives of the tax reductions, leaving the additional GDP in place.
[7] Paul Evans, The Relationship between Realized Capital Gains and Their Marginal Rate of Taxation, 1976-2004, IRET Dynamic Tax Analysis Series: Capital Gains (Oct. 9, 2009), http://iret.org/pub/CapitalGains-2.pdf.
[8] White House, Office of Management and Budget, Budget of the U.S. Government, FY2013, Analytical Perspectives, p. 491, http://www.whitehouse.gov/sites/default/files/omb/budget/fy2013/assets/spec.pdf.
[9] Ross W. Gorte, Carol Hardy Vincent, Laura A. Hanson, & Marc R. Rosenblum, Federal Land Ownership: Overview and Data, Congressional Research Service, Report R42346, Feb. 8, 2012, http://www.fas.org/sgp/crs/misc/R42346.pdf.
[10] For a fuller discussion of potential privatization opportunities, see Cato Institute, Cato Handbook for Policymakers, ch. 6 (7th ed., 2009), http://www.cato.org/pubs/handbook/hb111/hb111-6.pdf.
[11] Cato Institute, Cato Handbook for Policymakers, ch. 27 (5th ed., 1999), http://www.cato.org/pubs/handbook/hb105/105-27.pdf.
[12] Cato Institute, Tad DeHaven, Corporate Welfare in the Federal Budget, Policy Analysis No. 703 (July 25, 2012), http://www.cato.org/publications/policy-analysis/corporate-welfare-federal-budget."