Page 1. Evaluation of Tax Cut Based on What We Know and Acknowledging What We Don t Know

Transcription

1 Page 1 Evaluation of Tax Cut Based on What We Know and Acknowledging What We Don t Know

2 Agenda Summary of what tax cut is and isn t Macro evaluation Discussion of Just How Complicated Taxing Business Entities can be Page 2

3 Criteria of Analysis Criteria Short Run Long Run Economic Growth Jobs Unemployment Inflation Interest rates Federal deficits Federal debt International trade Distribution of Income Unintended Consequences Page 3

4 Common Tax Types Income and payroll taxes Property taxes Annual tax on value of taxable assets Sales taxes Estate taxes Commodity taxes Fuel (per unit) Sin taxes Other Hotel Travel Page 4

5 Purposes and Issues Funding government expenditures Raising funds efficiently Goal is frequently to minimally distort decision making by economic actors in private markets Definition of income isn t clear for all but wage and salaries Rising funds fairly Progressive taxes are a stated goal where the idea is the greater ones income, the greater a proportion of your income is paid in taxes Such a standard applied to business entities and corporations is fraught with problems Violated by design with many other forms of taxes Sales taxes are notoriously regressive Property taxes can have huge personal impacts because of differences between value and income Gas taxes are highly visible, unpopular, and structurally incapable of addressing technological change in the automobile engine Page 5

6 Caveat and Goals Raising or lowering taxes is inherently political There is significant differences of opinion regarding the distribution effects of various taxes particularly corporate taxes Good news: the Republican tax cut has led to several detailed summary analyses of the impacts of reducing the corporate income tax The conclusions: results appear highly sensitive to the political persuasions of the authors Overview: It s a far more complicated issue than anything you ve likely heard The macroeconomic consequences are clear and already emerging The distributional impacts of the personal income taxes are clear, those of reducing the corporate income tax are less clear Page 6

7 General Criteria for a Macroeconomist - I 1. Do the changes impact economic growth? If the answer is NO, then the impact of the tax is by definition distributional that is, there are winners and losers Note: identification of winners and losers can be very tricky when various exemptions are eliminated or enlarged. Distributional effects of changes to tax code impacting businesses is significantly more complicated than changes affecting households Major changes in corporate taxes provides to high income earners allowing businesses to change forms (e.g., corporate vs. pass through or individuals to form businesses to avoid higher personal income taxes.) Page 7

8 General Criteria for a Macroeconomist II&III 2. What is the level of unemployment in the economy when the bill becomes law? To assess whether the bill impacts economic growth, one of the key issues is what is the economy s capability of growing faster than its potential? This is based on the macroeconomic model discussed in earlier lectures If the economy is at potential GDP (or NAIRU), how could it stimulate growth? If stimulus is required, will this tax reform provide that stimulus? 3. Do the changes in taxes generate a deficit or are they revenue neutral? Impact on deficits at or near full employment are fundamentally different than impact when unemployment is high or the economy is shrinking. Page 8

9 More Initial Comments The Republican Tax Plan is extraordinarily complicated because of the many details that will affect corporate and business behavior and outcomes. There is never going to be tax simplification. Sounds appealing. It doesn t exist in reality. In a complicated economy tax laws have been and will be written to favor or disfavor one economic activity over another. Big examples: Mortgage interest deduction State and local income tax deductions Municipal bond interest is tax free Deductions for charitable contributions Capital gains preferential tax treatment Various business deductions Business and Corporate Taxation is significantly more complicated and more complicated to analyze. Page 9

10 Tax Cut Description The 2017 tax act changes corporate and individual tax rates and includes various provisions that affect how businesses and individuals calculate their taxable income. Lowers the top corporate income tax rate to 21 percent. It changes the way that the foreign income of U.S. corporations is taxed it reduces some incentives for corporations to shift profits outside the United States. Eliminates the penalty for not having health insurance a penalty imposed under a provision of the Affordable Care Act generally called the individual mandate. And it changes the measure of inflation that is used to adjust certain tax parameters. For the next eight years: the act lowers individual income tax rates and broadens the total amount of income subject to that tax. it increases the tax exemptions for property transferred at death and for certain gifts. Page 10

11 Changes Affecting Individuals and Families Income Taxes & Exemptions Issue Current Law New Law Notes Tax Brackets 7 7 Some changes Top rate 39.6% 37% Benefits those with very high incomes Alternative Minimum Tax Complex calculation that Keeps but increases Upper middle class to impacts higher income exemption high income taxpayers Standard Deduction $6,500/$13,000 $12,000/$24,000 May help lower middle Personal Exemptions $4,150 per taxpayer and incomes depending on Eliminates dependent # of dependents Child tax credit $1,000 $2,000 Refundable portion 15% of earnings over $3,000 Up to $1,400 Benefits lower income Credit for other dependents None $500 Family tax credits phase out $75,000/$110,000 $200,000/$400,000 Upper income families benefit Education Related Student Loan Interest Can deduct up to $2,500 Graduate student tuition waivers Tuition waivers exempt Deduction for class room $250 deduction No Change Page 11

12 Changes Affecting Individuals and Families Itemized Deductions Other Issue State & Local Tax Mortgage Interest Moving Expense Medical Expenses Current Law New Law Notes Income or sales tax and property tax are deductible Interest up to $1MM Mortgage All personal moving expemses. Employer reimbursements excluded Can deduct in excess of 10% of AGI Limited to $10,000 Limted to payment of $750,000 mortgage Elminates except for military Expands by reducing threshold to 7.5% Overall Limit $266,700/$320,000 No Change Individual Mandate Required under ACCA Repealed Estate Tax 40% above $5.6MM/$11.2MM Thresholds doubed Pass-through Income Taxed at Individual Rates 20% deduction Harms upper middle income in high tax states with high home prices Makes moving more costly Only applies to 2017 and 2018 Huge benefit to small # of wealthy families Benefit to highest income earners who can change status Page 12

13 Changes Affecting Businesses & Corporations Issue Current Law New Law Notes Top rate 35% 21% Alternative Minimum Tax Alternative tax calculation impacting businesses Eliminated Upper middle class to high income Business Interest Deduction Fully deductible New Investment Complex rules 5 Years Net Operating Losses Can deduct losses from income in prior years Capped at 30% of Income Limited to 80% of Taxable Income R& D Expenses Immediately deductible Written off gradually Note: there are many others. Page 13

14 Non Debatable Impacts: I Multiple elements of the tax bill favor the most affluent Raising the Estate Tax exemption Reduction in top rate on taxable income from 39.6% to 37% Reduction in Pass through tax rate on private businesses This creates a big tax cut for the most affluent workers who can game the tax code by creating a business entity through which they get compensated. Reduction in Corporate Income Tax rate Corporations will pass through much of their gains to shareholders rather than to workers or through lower prices. Yes, but by how much? Elimination of the health insurance mandate Will raise premiums over time by healthy people electing to drop out of insurance pool Page 14

15 Tax Cuts and Impact on Economic Growth Economists know a lot about stimulating economic growth through tax reductions when we are in a recession However Cutting income taxes for the least affluent is usually the most effective Reducing income taxes for the most affluent is the least effective We aren t in a recession The amount of excess capacity is debatable Personal income tax changes are Robin Hood in Reverse Impact on growth has probably already occurred. Page 15

16 Estimates of Distributional Impacts on Personal Income Taxes Tax Policy Center calculated: Income Group Avg. Tax Cut D in Aftertax Income Top 1% $51, % Middle Income $ % Lowest 20% $ % More than half of the benefits go to the top 10 percent of earners, so the tax cuts accrue disproportionately to high-income households. But The share of tax cuts accruing to the top 0.1% of taxpayers will rise from 8% in 2018 to an astounding 60% in 2027 if Congress doesn t extend the expiring cuts. Page 16

17 Estimates of Distributional Impacts Regressive components: Reducing the corporate income tax* Providing a sizable tax preference to pass-through business income Significantly reducing the estate tax Lowering the top income tax rate * Regressive if one is persuaded by research that much of the tax is paid by owners of capital and not labor Page 17

18 Non Debatable Impacts: II Some middle class taxpayers will benefit, some will pay more Outcome is specific to the circumstances of the individual taxpayer: Where the taxpayer lives (high property values) and whether they itemize or live in states with material state income tax rates. These are not permanent Impact of Individual Health Insurance Mandate will offset Inefficiencies in the Corporate Income Tax will be reduced Differential corporate income tax rates among countries can generate cross border tax arbitrage that generates profits but is economically inefficient So, reducing incentives for using these strategies generates an economic benefit. Comments. This effect is limited to multi-nationals and doesn t account for response of other countries It doesn t account for whether this generates additional investment in the U.S. Page 18

19 What Economists Say Different corporate income tax rates and rules among counties allow multi-national corporations to game these different structures by moving / locating activities in different countries. This is a known inefficiency in the global corporate tax system But, what is not known, the materiality of these effects Those benefits are very sensitive to precisely models are structured and what information is used to assess the impacts This issue doesn t affect solely domestic institutions, who will also benefit from the lower rate. claims that high U.S. tax rates will create problems for the United States in a global economy suffer from a misrepresentation of the U.S. tax rate compared to other countries and are less important when capital is imperfectly mobile, as it appears to be. Page 19

20 Page 20 MSNBC Analysis (Steve Rattner)

21 What the Tax Bill Would Look Like for 25,000 Middle-Class Families Page 21 It s just an estimate, but it is a picture of a the complexity of revising tax rules

22 NY Times: What the Earlier Tax Bill Would Look Like for 25,000 Middle-Class Families Pay Less Pay More Page 22

23 Page 23 Taxes and Distribution of Income

24 What Economists Say about Investment In the mean time There isn t much evidence that reducing the corporate income tax will generate material higher levels of investment Textbook models of investment include taxes as a cost of investment, but the results are sensitive to parameter estimates and those are highly sensitive to the models and data utilized to estimate the parameters There is a lot of evidence that it generates a significant cost to federal revenues Page 24

25 Poll of Economists at University of Chicago Business School Question: If the US enacts a tax bill similar to those currently moving through the House and Senate and assuming no other changes in tax or spending policy the US debt-to-gdp ratio will be substantially higher a decade from now than under the status quo. Page 25

26 Poll of Economists at University of Chicago Business School Tax Reform Question: If the US enacts a tax bill similar to those currently moving through the House and Senate and assuming no other changes in tax or spending policy US GDP will be substantially higher a decade from now than under the status quo. Page 26

27 Page 27 Some History on the Top Federal Marginal Rate

28 What is the Taxable Income at the Top Rate? Thousands of $ Not adjusted for inflation Does it matter? Page 28

29 What is the Taxable Income at the Top Rate? Thousands of $ When the red line is higher that means you had to earn more taxable income to be taxed at the highest rate Page 29

30 Highest Marginal Rate and Tax Receipts % of GDP Tax Rate (%) It requires a higher marginal rate on incomes that aren t that high to make much difference to tax receipts Page 30

31 Key Macroeconomic Relationship D GDP -D Unemployment D Jobs Page 31 They are ALL determined by similar macroeconomic forces

32 Page 32 CBO Forecast of GDP Impacts

33 GDP Potential Positive Impact of Tax Cut Quarterly % D GDP Page 33

34 Unemployment Unemployment Rate (%) Potential Positive Impact of Tax Cut Page 34

35 Jobs Monthly D in Jobs (000) Page 35 Period Avg Monthly D Jobs (000) Admin Jan '11 - Jan Obama Jan '13 - Jan ' Obama Jan '17 - Jan ' Trump Jan '18 - Nov ' Trump

36 Steve Rattner s ~ Graph on Morning Joe Job Growth: Last 23 Months of Obama Admin vs. First 23 of Trump Obama 210,304 Trump 198,565 Monthly D in Jobs (000) Page 36

37 Inflation and the Federal Reserve Annual Inflation Rate (%) 2% Target How the FOMC interprets this graph will determine how soon and how far interest rates are raised Page 37

38 Unemployment & Inflation Annual Inflation Rate (%) They re Focus: the Impact of Low Unemployment on Inflation Page 38

39 Conundrum Regarding Stimulus The economy was already below NAIRU when the stimulus from the tax cut was signed into law Based on the models of those that closely track the economy there was a short term boost to growth associated with the cut So, the key question remains: why did this stimulus not translate into much higher inflation? Meanwhile, one of the obvious costs of the tax bill is beginning to become obvious Page 39

40 CBO Deficit Baseline + Tax Impact $1.5 T in Add Debt Billions of $ $10.1 T of Deficits w/o Bill Even without the changes in the tax structure, the deficit is projected to grow significantly over the next several years adding over $10 Trillion to the Debt Held by the Public Page 40

41 CBO: Debt Baseline + Tax Deficits in Trillions of $ $10.1 T of Deficits w/o Bill Debt as % of GDP Page 41

42 CBO Baseline Federal Budget: Deficits and Debt $ Trillions CBO Forecast: $12 Trillion in Deficits % of GDP Page 42

43 Models and Estimates Modeler Static Cost Cost inc Stimulus Joint Committee on Taxation $1.63 $1.00 Penn Wharton Model $1.64 $1.39 Tax Foundation $1.78 $0.52 Models vary significantly on the effects on economic growth and the bias of the modeler Page 43

44 What s Missing from Debt Estimates? Factor Issue Comments 1 CBO forecast doesn't include impact of a recession As a rule, economists don't forecast recessions because impacts are too sensitive to timing even though at least one recession is highly likely over the next 10 years 2 3 CBO forecast includes assumptions about interest rates CBO forecast incoporates assumptions about the rate of technological progress A known unknown. Interest rates over the long-run are not forecastable A known unknown. Recent trends are extrapolated, but may understate or overstate future developments Page 44

45 Factor #1: Recession Stats %D Real GDP Period Months Recoveries Total In Recession % Longest Current Jan '47 - Dec ' Page 45 We have been in a recovery since June 2009 or for 32 Qtrs. Thinking a recession won t occur for another 10 years is unrealistic. Size of deficits are highly sensitive to economic activity

46 Key Caveat The further into the future one models the economy, the greater the uncertainty Page 46

47 Complexity of State and Local Tax Deduction The $10,000 cap on the itemized deduction of state and local taxes is one of the examples of broadening the tax base. This was one of the most progressive changes in the 2017 tax act. About 45 percent of the lost tax benefit would have gone to taxpayers with more than $500,000 of annual income. The deduction subsidizes sub-federal spending regardless of any externality involved. Page 47

48 Uncertainty: Fed Policy Responses There exists material uncertainty regarding how fast and how much the Fed will raise interest rates over the course of the next few years. If the Fed believes that the underlying potential growth is as the CBO currently estimates, then it is more likely to raise rates faster than what has been assumed in the CBO projections of the debt The deficit is sensitive to interest rate forecasts This would imply more debt being created and constraints on whatever stimulus is in the tax bill. Page 48

49 Inflation and the Federal Reserve Annual Inflation Rate (%) 2% Target How the FOMC interprets this graph will determine how soon and how far interest rates are raised Page 49

50 Real Fed Funds Rates at Economic Peaks Real Fed Funds Rate (%) ~3% difference Current Real Fed Funds Rate is much below average at this stage of economic performance Page 50

51 Federal Deficits and Trade Deficits Investment, Savings, and Trade Balance as % of GDP Savings by Component as % of GDP Federal deficits are negative savings Page 51

52 Real Avg. Weekly Wages Real Weekly Median Wages ($2018) Looks pretty good over time? Page 52

53 Real Avg. Weekly Wages Not Scaled Real Weekly Median Wages ($2018) How advocates position data matters Page 53

54 Notes on Corporate Income Taxes The Effects of Corporate Taxes are the Least Measureable and Very Controversial Among Researchers #1 Reason: Heterogeneity of Data at Point in Time and Over Time Page 54

55 2 Key Questions Q 1: Who Pays the Corporate Income Tax? Workers through lower wages? Owners of Capital (i.e., shareholders via lower stock prices and dividends)? Consumers (though higher prices)? Q 2: Does a Corporate Income Tax Lower Capital Investment in the U.S.? If so, then lowering the corporate income tax rate should raise investment in domestic capital. And, if so, workers wages should benefit. Yes, but by how much? And, are their more efficient ways of stimulating investment? Page 55

56 Static vs. Dynamic Issues To the extent higher corporate income taxes reduce investment in capital then Even if in the short-run that higher corporate taxes are passed through to the shareholder (via lower after-tax profits) Over the longer-run higher capital/labor ratios that increase labor productivity lead to higher wages Page 56

57 Why is Research on these Issues so Indeterminate Two Critical Questions have been Analyzed over 50 years To what extent does lowering the Corporate Income Tax increase investment? Who pays the Corporate Income Tax? Issues Complexity of data over firms, industries, time, and country Dependence on uncontrolled economic factors Sensitivity of results to model structure and data used: lack of robustness in results Dependence of results on behavioral responses by economic agents A leading researcher Trying to address the long-run incidence of general corporate income tax is a daunting task Page 57

58 Why Corporate Income Taxes are an Inefficient* Way to Stimulate Investment Cutting corporate income tax rates: Does not substantially reduce the cost of capital Impacts earnings associated with much larger existing capital use, not just new capital With expensing, the government is in effect a silent partner to private investment, bearing the same fraction of costs and revenues, and the extent the tax rate doesn t matter for the cost of capital * Efficiency = Tax revenues given up vs. Dollars of Investment Stimulated Page 58

59 Why Corporate Income Taxes are an Inefficient: The Math With a corporate income tax rate of tx, expensing of all costs and full deductibility of losses, the present value of equity financed investments is Σ((1 tx)r t (1 tx)c t )/(1 + r) t = (1 tx ) Σ(R t C t )/(1 + r) t. Simplified present value of future revenues and costs associated with a capital expenditure Those projects that have a positive present value (and thus are value enhancing investments) will still have a positive value independent of the value of tx the tax rate Those projects that do not have a present value, still do not regardless of tx, the corporate income tax rate. Page 59

60 Who Pays the Corporate Income Tax? Short Run vs. Long Run Closed vs. Open Economy If higher corporate income taxes lower the K/L ratio over time, workers pay Owners of Capital, Shareholders Corporation Workers Consumers Page 60

61 Shifting Income between Different Organizational Structures As long as taxes on individual income are imposed, a significant corporate income tax is likely to be necessary to forestall the use of the corporation as a tax shelter As long as taxes on individual income are imposed, a significant corporate income tax is likely to be necessary to forestall the use of the corporation as a tax shelter or vice versa Corporation LLC Tax paid on pretax earnings based on corporate tax rate Tax Paid on Income passed through to owners based on personal income tax rate Page 61

62 Very Simplified but Relevant View Corporation LLC Corp Tax Rate > Personal Income Tax Rate Corporation reorganizes as LLC. Owner pay tax based on lower personal income tax rate Corp Tax Rate < Personal Income Tax Rate LLC reorganizes as Corporation and owners/firm pay tax based on lower corporate tax rate Page 62

63 Gaming the Tax System through Business Redefinition After the Tax Reform Act of 1986: the top personal income tax rate fell below the corporate rate This generated a massive surge in businesses classifying themselves as pass-through entities like partnerships or S corporations whose income is not subject to the corporate income tax but instead becomes part of the individual taxable income for the owners Page 63

64 Federal Income Tax Revenues % of Federal Revenues Corporate Income Tax Revenues = $11.5 B / year Page 64

65 Distributional Impacts: Historical Perspective % of GDP Amazing Amount of Regularity in Shares of Income Distributed to Labor vs. Owners of Capital over 71 years. Page 65

66 Distributional Impacts: Taxes/Income % % Impact of Tax Bill Page 66

67 Did it Stimulate Investment? Investment as % of GDP Page 67

68 Did it Stimulate Investment? Investment as % of GDP Page 68

69 What about Personal Consumption? Personal Consumer Expenditures as % of GDP Page 69

70 Comparison Investment Expenditures as % of GDP Personal Consumer Expenditures as % of GDP Dec 2014-Dec 2015 Dec 2015-Dec 2016 Dec 2016-Dec 2017 Dec 2017-Sep 2018 Page 70 Period % D C Bus Inv

71 Page 71 International Corporate Tax Comparison

72 International Corporate Taxes: What Other Countries have Done since 2003 Most other counties have lowered their statutory rates Page 72

73 International Corporate Taxes: Who has the Highest Rate Depends on Definition Tax Rate (%) Page 73 Even assessing differences among countries is extremely complicated by the real world of taxes and deductions on corporate entities

74 What Do These Trends Tell Us? Not all boats rise with the tide Almost all major advanced economies have experienced the same changes in pretax (a.k.a. earnings ) distribution of income All regions in the U.S. have experienced similar trends All advanced economies mitigate the distributional effects of the economic structure, some more than others The major factors influencing distributional outcomes are inherent in the economy. The economic forces impact pre-tax distributions are not a function of policy Policies are confined to the redistributive powers of public taxing and spending policies. Page 74

75 Conclusions of Congressional Research Service It appears that most of the burden of the corporate tax falls on capital. Thus the tax is a progressive one that falls on capital incomes and thus largely on higher incomes. Reducing corporate income taxes is a regressive one benefitting capital incomes and largely on higher incomes Page 75

76 Page 76 Unintended (or Maybe Intended) Consequences of Tax Bill

77 The Consequence List Rising Federal debt/gdp ratios and potential political and economic consequences Crowding out public infrastructure purchases Distributional consequences of future cuts in Social Security, Medicare and Medicaid International trade impacts Removal of the Health Care Mandate Constraints on fiscal policy when the next recession occurs Page 77

78 The Biggest What About? The politics of the federal budget Will the rising debt provide more political power to those that want to cut future federal spending to reduce the forecast deficits: Medicare Social Security Medicaid/National Health Insurance If cuts in these programs occur because of the larger deficits, it ll diminish any supposed benefit to the middle class Page 78

79 Future Challenges: Funding for Entitlement Programs When does the growth in debt as proportion of GDP become a political issue and what will be the impact on entitlement programs? There are 2 ways to slow the rate of growth rate of federal debt: raising taxes or reducing outlays The biggest outlays are the entitlement programs Discretionary expenditures are a declining portion of the Federal budget If rising debt/gdp ratios generate political action, how will Congress and the Executive Branch address this issue? Page 79

80 Adverse Selection and Insurance Adverse selection in the insurance market refers generally to a situation where buyers have information than the insurers. With auto insurance, insurers use age/gender/driving histories in setting rates and deductibles and in some cases will not insure a driver poor driving records. In the case of health insurance, prior to the ACCA, adverse selection for individual policies was insurers unwillingness to insure individuals with pre-existing conditions. Under the ACCA, insurers no longer have the option to adjust insurance rates for pre-existing conditions. As insurance rates rise, without a mandate, young and healthy individuals will opt to leave the insurance pool or for buying less coverage leaving the less healthy insured in the ACCA pool. Over time, the relative prices in the healthy vs. less healthy pools will widen, providing further incentives for more healthy individuals to opt for cheaper, lower coverage insurance. Page 80

81 Repeal of Mandate and Challenges to ACCA Lack of mandate in the Affordable Care Act will: Increase the costs to all insured due to adverse selection. Incomplete insurance policies now allowed further deteriorates the risk pool covered by health insurance, because healthy people opt out. Rising insurance costs have budgetary impacts through Medicare and Medicaid programs. How will this be addressed? Page 81

82 Federal Deficit and Trade Deficit Will deteriorating trade deficit lead to additional tariffs? Trade and tariffs to be covered, but given proclivities of current administration and thinking that individual country deficits, expansion of tariffs will reduce economic growth. Page 82

83 Federal Deficits and Trade Deficits Investment, Savings, and Trade Balance as % of GDP Savings by Component as % of GDP Federal deficits are negative savings Page 83

84 Fiscal Stimulus when the Next Recession Occurs When the next recession occurs, will the outstanding Federal debt constrain policy makers from stimulating the economy? To the extent it does, a mild recession could worsen: generating more unemployment and lasting longer than it otherwise would Page 84

85 My Conclusion The tax bill s timing is not good It doesn t contain much stimulus, if any It does contain substantial costs in terms of higher deficits and debt These costs become much larger when the next recession hits It generates a lot of losers in the middle class over time The benefits to individuals and families will expire in the bill It differentially impacts selected groups It will pose significant challenges to social spending in the future when the real debt numbers begin to rise These challenges exist without the changes, but they are made more challenging by the loss of federal revenues Page 85

86 Conclusion Criteria Short Run Long Run Economic Growth Jobs Unemployment small + - small + small + 0 small lower 0 Inflation 0 0 Interest rates 0 0 Federal deficits Federal debt International trade Distribution of Income Unintended Consequences much larger much larger Larger trade deficit less equal all bad much larger much larger Larger trade deficit much less equal all bad Page 86