Using Dynamic Analysis Makes Tax Reform Less Challenging

September 4, 2013

Led by Chairman Dave Camp (R-Mich.), the House Ways and Means Committee is developing a plan to dramatically simplify the tax code, eliminate numerous tax preferences, and cut individual and corporate tax rates. By most accounts, the plan would cut the top corporate tax rate to 25 percent, reduce the highest individual tax brackets to 25 percent, and reduce the 15 percent individual rate to 10 percent. Camp has promised that the plan would be revenue neutral, meaning that broadening the tax base and eliminating numerous tax preferences would offset revenue losses from the rate cuts, say Scott A. Hodge, Stephen J. Entin and Michael Schuyler of the Tax Foundation.

In an effort, no doubt, to illustrate the enormity of Camp's task, Congressman Sander Levin (D-Mich.), the ranking Democrat on Ways and Means, recently asked the Joint Committee on Taxation (JCT) to estimate the revenue losses associated with such a tax rate cut plan.

  • JCT's estimate: more than $5 trillion in lost revenues over 10 years.
  • Indeed, finding enough "loopholes" to offset just the corporate rate cut alone may be nearly impossible on a static basis.
  • The JCT estimated that the average cost of cutting the corporate rate would be almost $130 billion annually.

In order to provide lawmakers with a more complete picture of the costs and benefits of these tax changes, Tax Foundation economists performed the same analysis using its Dynamic Tax Simulation Model, which simulates the long-term economic and fiscal effects of tax policy changes.

  • Macroeconomic analysis shows that cutting individual and corporate tax rates with no offsets would boost the level of gross domestic product by more than $2 for every $1 of net dynamic revenue that it "loses" for the Treasury.
  • Moreover, this simulation shows that the rate cuts would increase wages by 2.75 percent.
  • It would do this by lowering the cost of capital in the economy, boosting labor productivity and leading to higher wages.
  • The resulting higher incomes would produce enough additional tax revenues to offset nearly 30 percent of the cost of the initial tax reduction.

Source: Scott A. Hodge, Stephen J. Entin and Michael Schuyler, "Using Dynamic Analysis Makes Tax Reform 30 Percent Less Challenging," Tax Foundation, August 26, 2013.

 

Browse more articles on Tax and Spending Issues