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Magazine 24
What Are
Economists Really Saying About Tax Rate Increases?
by Salim Furth, Ph.D
Beware of comparing apples to oranges when it comes to tax rate studies.
On Friday, Representative Pete Sessions (R–TX) and House Speaker John
Boehner (R–OH) ran afoul of Glenn Kessler’s “Fact Checker” blog
regarding a study of President Obama’s proposed tax increase. Before
deciding on a tax change, policymakers are wise to look at the economic
impacts of the change.
Two Studies
In fact, two studies released this year predict that raising tax rates
on high-income families and small businesses would hurt the economy.
The tax rate increase was proposed by President Obama and involves
raising the top two marginal tax rates to 39.6 percent and 36 percent,
respectively.
The first of the two studies was performed by Ernst and Young, a large
consultancy, for a group of clients representing small businesses. They
used Ernst and Young’s proprietary macroeconomic model to evaluate the
long-run economic cost of the proposed tax increase, along with tax
increases on dividends and capital gains.
The second study was performed by the Congressional Budget Office (CBO)
and focuses on the short-term impact of the tax increase on high-income
taxpayers. The CBO report must be read carefully, since the baseline is
current law, in which tax rates will rise across the board.
Jobs Impact
The Ernst and Young study predicts that the tax increases will slow
investment, resulting in slower growth in employment and wages.
Compared to their model’s baseline predictions, the higher-tax economy
would have 0.33 percentage point lower employment after 10 years and
would asymptotically approach 0.5 percentage point lower employment. In
terms of today’s population, that would be 710,000 fewer people holding
jobs. In addition, real wages for those with jobs would decrease by 1.8
percent on average.
Because the effects take place over time, they may seem small in any
given year, but they build. Long-run models don’t focus on the timing
with which effects come into play. However, based on their 10-year
figure, a back-of-the-envelope calculation shows that the model
probably predicts more than 2.6 million job-years lost in the first
decade. If strong effects of the tax increase are felt immediately, as
the second study suggests, then the lost job-years in the first decade
might be around 3.4 million.
The CBO report estimates that a year from now, the economy will have
200,000 fewer jobs with President Obama’s tax increase than under an
extension of current tax rates.
How does the 200,000 job loss predicted by CBO compare to the 710,000
job loss in the Ernst and Young study? Like apples to oranges. Not only
are the time frames different, but the key economic mechanisms in each
study are different. Nonetheless, despite asking different questions,
the two studies get the same answer: Higher taxes slow job growth.
What Happens to All That Money?
One of Kessler’s criticisms is that the Ernst and Young study assumes
that the additional revenue from the tax increase would be used to fund
more government spending, not to reduce the deficit. This is a
reasonable assumption—after all, Harvard economist Alberto Alesina and
his co-authors have shown that increasing taxes to decrease the deficit
rarely works, and the President has promised lots of new federal
spending in his second term. And if the Ernst and Young model is
similar to others in the industry, the assumption that new taxes are
used to fund government spending mitigates the predicted job losses.
Thus, the “710,000 jobs lost” is smaller than it would be if the new
taxes went entirely to deficit reduction.
Are These Numbers Big or Small?
Kessler seems to imply that the economic costs predicted by the Ernst
and Young study are small. So let’s compare the economic costs to the
revenue that the new taxes might yield. According to the left-leaning
Tax Policy Center, such a tax increase would bring in $440 billion over
10 years, even if the economy were unaffected. If the tax increases
result in a loss of 3 million jobs over the same 10 years, that would
be one job lost for every $150,000 in revenue. In addition, wages,
investment, and gross domestic product (GDP) would also be lower.
That’s a pretty pricey tax increase.
Will the Tax Increases Make a Dent in the Debt?
Kessler correctly points out that high debt can slow economic growth,
as recent scholarship has shown. Will the revenue gains from higher tax
rates outweigh the revenue losses from lower wages and lower
employment? And is this an efficient way to slow the growth of the
national debt?
The Ernst and Young study predicts that long-run GDP with the higher
tax rates would be 1.3 percent smaller. If that 1.3 percent of lost GDP
had been taxed at 20 percent (a conservative guess), then the loss of
tax revenues from smaller GDP would be about the same size as the
static revenue gains estimated by the Tax Policy Center.
Without modeling all these components together in the same framework,
one cannot be certain how to relate them, but the best evidence is that
the costs of the tax increase are large compared to its benefits.
Source: blog.heritage.org
Read this and other articles at Mail Magazine 24
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