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The Tax Reform Act of 2014 and Economic Growth

On February 26, 2014, House Ways and Means Committee Chairman Dave Camp (R-MI) released his long-awaited comprehensive tax reform plan.  The...

On February 26, 2014, House Ways and Means Committee Chairman Dave Camp (R-MI) released his long-awaited comprehensive tax reform plan.  The plan did not disappoint.  After three years of work, Chairman Camp and his talented staff have produced an important document – one that may be viewed as the starting point for comprehensive tax reform.  Titled the “Tax Reform Act of 2014,” it is 979 pages long with extensive reform of both the individual and corporate income tax systems.  The centerpiece of the plan is the lowering of both the top individual and corporate tax rates to 25 percent with a 10 percent surtax on the individual side.  Coupled with the lowering of both the individual and corporate tax rates is a significant broadening of the tax base.  A number of exclusions, deductions and credits have been eliminated or significantly scaled back.  The result is a comprehensive tax plan that is almost revenue neutral — it is scored to raise $3 billion over ten years — and distributionally neutral. 

One of the most interesting documents that accompanied the release of Chairman Camp’s tax plan is the Joint Committee on Taxation’s macroeconomic analysis of the plan.  The Joint Committee is a nonpartisan committee composed of five members of the Ways and Means Committee and five members of the Senate Finance Committee.  It has a staff composed of lawyers, accountants and economists that provide tax assistance to members of Congress.  The economists also provide revenue estimates for tax bills.  In determining revenue estimates, the Joint Committee staff incorporates many types of behavioral responses while assuming a fixed gross national product (GNP).  This type of revenue estimate is sometimes referred to as static estimating or scoring, which is actually an erroneous term as such term implies that behavioral effects are ignored.  In 1996, the Joint Committee staff began developing a capacity to model the macroeconomic impacts of tax policy.  This generally means that GNP is not fixed and economic growth is considered as part of the revenue estimate.  This type of revenue estimate is generally referred to as dynamic estimating or scoring. 

In analyzing the macroeconomic effects of Chairman Camp’s tax plan, the Joint Committee staff utilized two models with a number of assumptions associated with each model.  The staff determined that the lower effective marginal tax rates provide an incentive for increased labor effort and, in some cases, increased business investment.   In addition, increasing the after-tax income of households provides an incentive for increased consumer purchases of goods and services.  The Joint Committee staff utilized a number of assumptions in its models, including Federal Reserve policy and the responsiveness of labor.

The Joint Committee staff determined that, under the various modeling assumptions, Chairman Camp’s tax plan would increase economic growth as measured by changes in gross domestic product (GDP) relative to the present law baseline over the ten-year budget window.  More specifically, GDP was projected to increase by as little as 0.1 percent to as much as 1.6 percent over the period of 2014-2023. 

Chairman Camp has touted the economic growth benefits of his tax plan, as he should.  For example, the press release accompanying the release of the tax plan noted that the plan creates up to 1.8 million new private sector jobs, increases GDP by up to $3.4 trillion (the equivalent of 20 percent of today’s economy), and generates up to an additional $700 billion in tax receipts over the 2014-2023 budget window as a result of increased employment and higher wages.  In addition, the press release notes that the average middle-class family of four could have an extra $1,300 per year in its pocket from the combination of lower tax rates in the plan and higher wages due to a stronger economy.

Chairman Camp has chosen his words carefully.  The economic benefits touted in the press release are the high end of the Joint Committee staff’s estimates and therefore the use of the words “up to” and “could have” make the statements accurate.  But it is important to note that the Joint Committee staff provided a range of estimates and therefore the economic benefits could be substantially less.  For example, according to the Joint Committee staff, the revenues generated from the tax plan fall within a range of $50 billion to $700 billion over the 2014-2023 budget window. 

The Joint Committee staff’s document analyzing the macroeconomic effects of Chairman Camp’s tax plan is an important document.  It lends support to the argument that comprehensive tax reform can lead to economic growth, which has been the subject of debate for many years.  In all of its assumptions utilizing the two different models, the Joint Committee staff determined that Chairman Camp’s tax plan would lead to an increase in GDP.  In other words, all the results point in one direction – an increase in GDP.  Unfortunately, the range of increase in GDP is so broad that it is hard to know whether the estimated increase in GDP is so small as to be almost negligible (0.1 percent) or whether the increase is significant (1.6 percent).