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June 07, 2019
The Tax Cut and Jobs Act, SALT, and the Blue State Blues: It's All Relative
Nearly two months have passed since tax day, but the full impact of the 2017 Tax Cut and Jobs Act (TCJA) has yet to be fully assessed. Both the data, and in fact the rules themselves, are still incomplete. Nonetheless, conventional wisdom seems to hold that the legislation created winners and losers, and that the losers primarily reside in so-called "blue" states—those where the majority of voters have consistently gone for the Democratic presidential candidate in recent elections.
The source of this belief springs from the newly imposed limitations on federal deductions of state and local taxes, or SALT, and the disproportional impact of these limitations on taxpayers in high-tax, high-income states—the majority of which are blue. A CNBC report from last week on pushback from blue-state politicians summarizes a typical reaction: "Lawmakers from high-tax districts say their constituents have suffered from the provision in the tax plan."
Is this view justified? In our own research, we focus on the long-term effects of the TCJA with the assumption that the legislation's provisions eventually become permanent. (The individual tax cuts are currently scheduled to expire in 2025.) Examining individual households from the 2016 Federal Reserve Board of Governors' Survey of Consumer Finances and incorporating state-specific tax provisions, we reached a few major conclusions regarding TCJA's impact.
First, the overwhelming majority of taxpayers across the country stand to enjoy lifetime gains in after-tax income as a result of the TCJA. The following chart documents our estimates of lifetime gains in every state and the District of Columba, by state-specific wealth quintile. (Wealth here is defined inclusive of human wealth—that is, it includes the present-value of expected wage and salary income.) The chart has a lot of information, but the key point here is the preponderance of blue-shaded areas, which represent the proportion of gainers in each wealth quintile, in each state. Outright losers—represented in the chart by the red shaded areas in each row—are confined to a very small proportion of the wealthy.
What is true is that the tax cuts were relatively more favorable, in percentage terms, to red-state residents. Our estimates show that the percentage reduction in the present value of lifetime taxes for red states is nearly twice that of blue states—but not in absolute terms. We calculate the average change in lifetime after-tax income for individuals in blue states to be $25,781, compared to a $23,094 average for red states. (In absolute terms, "purple" states—those averaging less than a 5 percent margin for either party over the past five election cycles—had the largest average gain of all, at $27,042.)
Another point worth emphasizing: the relatively smaller blue-state gains don't result from the fact that they are high-income states but instead result from the fact that they are high-tax states. When we control for the demographic make-up of states—and hence keep the income distribution across states constant—we get essentially the same implications for the distribution of TCJA tax gains.
It is likely true that blue-state taxpayers didn't gain as much as their red-state counterparts as a result of the TCJA. But for the most part, our estimates suggest they did indeed gain.
March 22, 2019
A Different Type of Tax Reform
Two interesting, and important, documents crossed our desk last week. The first was the 2019 edition of the Economic Report of the President. What particularly grabbed our attention was the following statement from Chapter 3:
Fundamentally, when people opt to neither work nor look for work it is an indication that the after-tax income they expect to receive in the workforce is below their "reservation wage"—that is, the minimum value they give to time spent on activities outside the formal labor market.
That does not strike us as a controversial proposition, which makes the second of last week's documents—actually a set of documents from the U.S. Department of Health and Human Services (HHS)—especially interesting.
In that series of documents, HHS's Nina Chien and Suzanne Macartney point out a couple of things that are particularly important when thinking about the effect of tax rates on after-tax income and the incentive to work. The first, which is generally appreciated, is that the tax rates that matter with respect to incentives to work are marginal tax rates—the amount that is ceded to the government on the next $1 of income received. The second, and less often explicitly recognized, is that the amount ceded to the government includes not only payments to the government (in the form of, for example, income taxes) but also losses in benefits received from the government (in the form of, for example, Medicaid or child care assistance payments).
The fact that effective marginal tax rates are all about the sum of explicit tax payments to the government and lost transfer payments from the government applies to us all. But it is especially true for those at the lower end of the income distribution. These are the folks (of working age, anyway) who disproportionately receive means-tested benefit payments. For low-wage workers, or individuals contemplating entering the workforce into low-wage jobs, the reduction of public support payments is by far the most significant factor in effective marginal tax rates and the consequent incentive to work and acquire skills.
The implication of losing benefits for an individual's effective marginal tax rate can be eye-popping. From Chien and Macartney (Brief #2 in the series):
Among households with children just above poverty, the median marginal tax rate is high (51 percent); rates remain high (never dipping below 45 percent) as incomes approach 200 percent of poverty.
Our own work confirms the essence of this message. Consider a representative set of households, with household heads aged 30–39, living in Florida. (Because both state and local taxes and certain transfer programs vary by state, geography matters.) Now think of calculating the wealth for each household—wealth being the sum of their lifetime earnings from working and the value of their assets net of liabilities—and grouping the households into wealth quintiles. (In other words, the first quintile would the 20 percent of households with the lowest wealth, the fifth quintile would be the 20 percent of households with the highest wealth.)
What follows are the median effective marginal tax rates that we calculate from this experiment:
Median Effective Marginal Tax Rate
Consistent with Chien and Macartney, the median effective marginal tax rates for the least wealthy are quite high. Perhaps more troubling, underlying this pattern of effective tax rates is one especially daunting challenge. The source of the relatively high effective rates for low-wealth individuals is the phase-out of transfer payments, some of which are so abrupt that they are referred to as benefits, or fiscal, cliffs. Because these payments differ widely across family structure, income levels within a quintile, and state law, the marginal tax rates faced by individuals in the lower quintiles are very disparate.
The upshot of all of this is that "tax reform" aimed at reducing the disincentives to work at the lower end of the income scale is not straightforward. Without such reform, however, it is difficult to imagine a fully successful approach to (in the words of the Economic Report) "[increasing] the after-tax return to formal work, thereby increasing work incentives for potential entrants into the labor market."
January 17, 2018
What Businesses Said about Tax Reform
Many folks are wondering what impact the Tax Cuts and Jobs Act—which was introduced in the House on November 2, 2017, and signed into law a few days before Christmas—will have on the U.S. economy. Well, in a recent speech, Atlanta Fed president Raphael Bostic had this to say: "I'm marking in a positive, but modest, boost to my near-term GDP [gross domestic product] growth profile for the coming year."
Why the measured approach? That might be our fault. As part of President Bostic's research team, we've been curious about the potential impact of this legislation for a while now, especially on how firms were responding to expected policy changes. Back in November 2016 (the week of the election, actually), we started asking firms in our Sixth District Business Inflation Expectations (BIE) survey how optimistic they were (on a 0–100 scale) about the prospects for the U.S. economy and their own firm's financial prospects. We've repeated this special question in three subsequent surveys. For a cleaner, apples-to-apples approach, the charts below show only the results for firms that responded in each survey (though the overall picture is very similar).
As the charts show, firms have become more optimistic about the prospects for the U.S. economy since November 2016, but not since February 2017, and we didn't detect much of a difference in December 2017, after the details of the tax plan became clearer. But optimism is a vague concept and may not necessarily translate into actions that firms could take that would boost overall GDP—namely, increasing capital investment and hiring.
In November, we had two surveys in the field—our BIE survey (undertaken at the beginning of the month) and a national survey conducted jointly by the Atlanta Fed, Nick Bloom of Stanford University, and Steven Davis of the University of Chicago. (That survey was in the field November 13–24.) In both of these surveys, we asked firms how the pending legislation would affect their capital expenditure plans for 2018. In the BIE survey, we also asked how tax reform would affect hiring plans.
The upshot? The typical firm isn't planning on a whole lot of additional capital spending or hiring.
In our national survey, roughly two-thirds of respondents indicated that the tax reform hasn't enticed them into changing their investment plans for 2018, as the following chart shows.
The chart below also makes apparent that small firms (fewer than 100 employees) are more likely to significantly ramp up capital investment in 2018 than midsize and larger firms.
For our regional BIE survey, the capital investment results were similar (you can see them here). And as for hiring, the typical firm doesn't appear to be changing its plans. Interestingly, here too, smaller firms were more likely to say they'd ramp up hiring. Among larger firms (more than 100 employees), nearly 70 percent indicated that they'd leave their hiring plans unchanged.
One interpretation of these survey results is that the potential for a sharp acceleration in GDP growth is limited. And that's also how President Bostic described things in his January 8 speech: "For now, I am treating a more substantial breakout of tax-reform-related growth as an upside risk to my outlook."
November 13, 2012
(Fiscal) Cliff Notes
Since it is indisputably the policy question of the moment, here are a few of my own observations regarding the "fiscal cliff." Throughout, I will rely on the analysis of the Congressional Budget Office (CBO), as reported in the CBO reports titled An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022 and Economic Effects of Policies Contributing to Fiscal Tightening in 2013.
Since the CBO analysis and definitions of the fiscal cliff are familiar to many, I will forgo a rehash of the details. However, in case you haven't been following the conversation closely or are in the mood for a refresher, you can go here first for a quick summary. This "appendix" also includes a description of the CBO's alternative scenario, which amounts to renewing most expiring tax provisions and rescinding the automatic budget cuts to be implemented under the provisions of last year's debt-ceiling extension.
On, then, to a few facts about the fiscal cliff scenario that have caught my attention.
1. Going over the cliff would put the federal budget on the path to sustainability.
If reducing the level of federal debt relative to gross domestic (GDP) is your goal, the fiscal cliff would indeed do the trick. According to the CBO:
Budget deficits are projected to continue to shrink for several years—to 2.4 percent of GDP in 2014 and 0.4 percent by 2018—before rising again to 0.9 percent by 2022. With deficits small relative to the size of the economy, debt held by the public is also projected to drop relative to GDP—from about 77 percent in 2014 to about 58 percent in 2022. Even with that decline, however, debt would represent a larger share of GDP in 2022 than in any year between 1955 and 2009.
Such would not be the case should the status quo of the CBO's alternative scenario prevail. Under (more or less) status quo policy, the debt-to-GDP ratio would rise to a hair under 90 percent by 2022:
The current debt-to-GDP ratio of 67 percent is already nearly double the 2007 level, which checked in at about 36 percent. However, though the increase in the debt-to-GDP ratio over the past five years is smaller in percentage terms, a jump to 90 percent from where we are today may be more problematic. There is some evidence of "threshold effects" that associate negative effects on growth with debt levels that exceed a critical upper bound relative to the size of the economy. At the Federal Reserve Bank of Kansas City's 2011 Economic Symposium, Steve Cecchetti offered the following observation, based on his research with M.S. Mohanty and Fabrizio Zampolli:
Using a new dataset on debt levels in 18 Organisation for Economic Co-operation and Development (OECD) countries from 1980 to 2010 (based primarily on flow of funds data), we examine the impact of debt on economic growth....
Our results support the view that, beyond a certain level, debt is bad for growth. For government debt, the number is about 85 percent of GDP.
Of course, causation is always a tricky thing to establish, and Cecchetti et al. are clear that their estimates are subject to considerable uncertainty. Still, it is clear that the fiscal cliff moves the level of debt in the right direction. The status quo does not.
2. The fiscal cliff moves in the direction of budget balance really fast.
By the CBO's estimates, over the next three years the fiscal cliff would reduce deficits relative to GDP by about 6 percentage points, from the current ratio of 7.3 percent to the projected 2015 level of 1.2 percent.
Deficit reduction of this magnitude is not unprecedented. A comparable decline occurred in the 1990s, when the federal budget moved from deficits that were 4.7 percent of GDP to a surplus equal to 1.4 percent of GDP. However, that 6 percentage point change in deficits relative to GDP happened over an eight-year span, from 1992 to 1999.
It is probably also worth noting that the average annual rate of GDP growth over the 1993–99 period was 4 percent. The CBO projects real growth rates over the next three years at 2.7 percent, which incorporates two years of growth in excess of 4 percent following negative growth in 2013.
The upshot is that, though the fiscal cliff would move the federal budget in the right direction vis à vis sustainability, it does so at an extremely rapid pace. I'm not sure speed kills in this case, but it sounds pretty risky.
3. The fiscal cliff heavily weights deficit reduction in the direction of higher taxation.
Over the first five years off the cliff, almost three-quarters of the deficit reduction relative to the CBO's no-cliff alternative would be accounted for by revenue increases. Only 28 percent would be a result of lower outlays:
The balance shifts only slightly over the full 10-year horizon of the CBO projections, with outlays increasing to 34 percent of the total and revenues falling to 66 percent.
Particularly for the nearer-term horizon, there is at least some evidence that this revenue/outlay mix may not be optimal. A few months back, Greg Mankiw highlighted this, from new research by Alberto Alesina, Carlo Favero, and Francesco Giavazzi:
This paper studies whether fiscal corrections cause large output losses. We find that it matters crucially how the fiscal correction occurs. Adjustments based upon spending cuts are much less costly in terms of output losses than tax-based ones. Spending-based adjustments have been associated with mild and short-lived recessions, in many cases with no recession at all. Tax-based adjustments have been associated with prolonged and deep recessions.
Of course, that in the end is a relatively short-run impact. It does not directly confront the growth aspects of the policy mix associated with fiscal reform. Controversy on the growth-maximizing size of government and the best growth-supporting mix of spending and tax policies is longstanding. The dustup on a Congressional Research Services report questioning the relationship between top marginal tax rates and growth is but a recent installment of this debate.
Here's what I think we know, in theory anyway: Government spending can be growth-enhancing. Tax increases can be growth-retarding. It's all about the tradeoffs, the details matter, and unqualified statements about the "right" thing to do should be treated with suspicion. (If you are an advanced student of economics or otherwise tolerant of a bit of a math slog, you can find an excellent summary of the whole issue here.)
In other words, there are lots of decisions to be made—and it would probably be better if those decisions are not made by default.
By Dave Altig, executive vice president and research director at the Atlanta Fed
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October 17, 2011
State and local fiscal fortunes: Follow the money (collected)
Last week, we found ourselves in conversation with some colleagues discussing the issue of state and local fiscal conditions, which by pure coincidence coincided with the announcement that the city of Harrisburg, Pa., filed for bankruptcy. In the course of conversation, our attention was drawn to an interesting fact. Prior to 2000, according to U.S. Census Bureau data through 2008, annual growth of total revenues at the state and local level was closely aligned with direct expenditures at the same level. Since 2000, however, this pattern has decidedly changed. The main reason is the dramatic volatility of total revenue:
Revenues at the state and local level come from many sources. Taxes from income, sales, and property, of course, but also from various fees and charges associated from education, utilities, ports and airports, and so on. In addition, revenues come from transfers from the federal government and, importantly, asset income from trust fund portfolios.
In fact, the primary source of the increased volatility in state and local government revenues since 2000 is large swings in revenue going into insurance trust funds to finance compulsory or voluntary social insurance programs operated by the public sector.
Insurance trust revenue is derived from contributions, assessments, premiums, or payroll "taxes" required of employers and employees. It also includes any earnings on assets held or invested by such funds. Not surprisingly then, the volatility of insurance trust revenue is partly tied to volatility in financial markets, as the chart below clearly illustrates.
Though fluctuations in insurance fund revenues have been the largest source of fluctuations in overall state and local revenues over the past decade or so, volatility in general revenue is still an issue. Ups and downs in income tax revenues have been particularly sharp since 2000.
Interestingly, Census Bureau data for state government finances show tax revenue growth turned negative in 2009.
In research that focuses specifically on revenue variability at the state level, UCLA law professor Kirk Stark notes the possibility that state revenues have too much reliance on the same income-centric tax base that characterizes the federal revenue code:
"Perhaps the most obvious (yet little discussed) federal inducement for the design of state and local tax systems is the fact that Congress has established an elaborate and detailed legal framework for certain taxes—including, most notably, the individual and corporate income taxes—but not for others. The very existence of the Code, Treasury Regulations, IRS administrative guidance, and federal judicial case law creates an almost irresistible incentive for the states to adopt individual and corporate income taxes. The availability of the federal income tax base as a starting point in calculating state tax liability is an unqualified benefit. …
"At the same time, however, there are potentially significant costs associated with having states piggyback on the federal income tax. Taxes that might be suitable for use by a central level of government are not necessarily appropriate for use by state or local governments. Some of the most volatile state revenue sources are those upon which states rely by virtue of piggybacking on the federal income tax."
The theme of Professor Stark's article is the role that federal policy might play in generating revenue volatility at the state level:
"Through various inducements and limitations embedded in federal law, the federal government has stacked the deck in favor of state revenue volatility, unwittingly exacerbating the subnational fiscal crises that it is then called upon to mitigate through bailouts and general fiscal relief."
Some other examples of how federal tax policy can have an impact on state and local policy according to Stark include "differential treatment of alternative tax sources within the federal income tax deduction for state and local taxes" and "various specific provisions in federal law that limit state taxing authority."
Professor Stark is clear on the point that the research in this area has defied simple generic conclusions about how state and local tax codes can be constructed to minimize revenue volatility. And the work is largely silent on how the volatility question fits into the broader question of optimal tax-system design. But it is hard to argue with this conclusion:
"If the federal government is interested in reducing the likelihood and severity of future state fiscal crises, it should consider changes to federal law that would eliminate the current bias in favor of volatile state tax systems."
By Dave Altig, senior vice president and research director at the Atlanta Fed
John Robertson, vice president and senior economist in the Atlanta Fed's research department
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May 19, 2011
The long and short (runs) of tax reform
In an earlier part of my career, I spent a fair amount of time thinking about fiscal policy issues. The evolution of my responsibilities eventually moved my attentions in a somewhat different direction, but you never really forget your first research love. With questions of debt, government spending, and taxes at the top of the news, it isn't hard for my old fondness for the topic to reemerge.
So, in that context, I had a somewhat nostalgic response to an item at Angry Bear, written by contributor Dan Crawford. In essence, the Crawford post formally (through statistical analysis) asks the question "How is GDP growth related to marginal tax rates (that is, the tax rate applied to your last dollar of income)?" More specifically, Crawford analyzes how gross domestic product (GDP) growth next year is related to the marginal tax rate faced by the average individual and the marginal tax rate faced by the highest-income taxpayers.
I don't intend to quibble with the specifics of that experiment per se but rather highlight an aspect of taxation and tax reform that I think should not be forgotten. That is, the short run is no place for a decent discussion of tax policy to be hanging out. To say that more formally, the largest effects of tax policy accrue over time, and it is probably not a good idea to be too focused on the immediate—say, next year's—effects of any given policy or change in policy.
The following chart is based on tax reform experiments in a paper I co-authored over a decade ago with Alan Auerbach, Larry Kotlikoff, Kent Smetters, and Jan Walliser. (Note that the chart does not appear in the paper, but I created it using data from the paper—a publicly available version of the paper can be found here.) The chart depicts the cumulative percentage increases in national income that would be realized (in our model) in the years following three different tax reforms.
The three experiments depicted in this chart were as follows:
"[The clean income tax] replaces the progressive taxation of wage income with a single rate that is also applied to capital income. In addition, the clean income tax eliminates the major federal tax-base reductions including the standard deduction, personal and dependent exemptions, itemized deductions, the deductibility of state income taxes at the federal level, and preferential tax treatment of fringe benefits...
"Our flat tax experiment modifies the clean consumption tax by including a standard deduction of $9500. In addition, housing wealth, which equals about half of the capital stock, is entirely exempt from taxation."
Parenthetically, the "clean consumption tax"
"...differs from the clean income tax by including full expensing of investment expenditures. This produces a consumption-tax structure. Formally, we specify the system as a combination of a labor-income tax and a business cash-flow tax."
"Our [flat tax with transition relief] experiment adds transition relief to the flat tax by extending pre-reform depreciation rules for capital in place at the time of the tax reform."
Here's what I want to emphasize in all of this. If the change in policy you might be considering involves a reduction in effective marginal tax rates (implemented via a combination of changes in statutory rates and adjustments in deductions and exemptions), the approach taken by Crawford in his Angry Bear piece is probably acceptable. The clean income tax reform is in the spirit of Crawford's calculations, and in our results the long-run impact on output is realized almost immediately. If, however, the tax reform involves changing the tax base in a fundamental way (in both versions of our flat tax experiments the base shifts from income to consumption), then the ultimate effects are felt only gradually. In our flat tax experiments, the longer-run effects on income are in the neighborhood of three times as large as the near-term effects.
All of the experiments described were done under the assumption of revenue neutrality, so questions of the right policy for budget balancing exercises weren't explicitly addressed. (Nor is it the nature of the experiment contemplated in the Angry Bear post.) Nonetheless, they do suggest that deficit reduction exercises that involve changes in tax rates and the tax base will have differential effects over time, and realizing the full benefits of tax reform may require a modicum of patience.
Note: A user-friendly description of the paper that the chart above is based on appeared in an Economic Commentary article published by the Cleveland Fed.
Update: Though the item at Angry Bear was posted by Dan Crawford, Mike Kimel actually wrote it. I apologize for the mistake and draw your attention to Kimel's follow-up post.
By Dave Altig
senior vice president and research director at the Atlanta Fed
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October 27, 2010
Real estate and municipal revenue
It's no secret that state and local governments are currently experiencing substantial revenue declines. One popular explanation is that deteriorating local real estate conditions are responsible for a portion of that decline, but it turns out that this explanation is not the main cause, at least not yet. One of the sessions in the conference featured attempts by three economists from the Federal Reserve Board of Governors (Lutz, Molloy, and Shan) and two from Florida State University (Doerner and Ihlanfeldt) to estimate the direct impact of the decline in real estate values on local tax revenues. Both papers examined the multiple channels of influence between the decline in real estate values and local revenues.
The largest channel, of course, is the decline in property tax income related to declining assessed property values. Of course, property owners don't pay property taxes based on the current value of their home. They pay based on an assessment that is at least a year old. Thus, the decline in property values takes considerable time to work its way through the assessment process and into property tax revenues. Consequently, declines in property values have only more recently started to be reflected in lower property tax revenues. Experts expect the decline in those revenues to continue for another couple of years, with the worst shortfall two or three years out. Some of the assessments are fairly gloomy.
To illustrate that point, I've pulled a few charts from the Lutz, Molloy, and Shan paper. The first chart illustrates the decline in revenues led by individual and sales taxes. Notably, property tax collections grew at an increasing rate in 2009 over 2008.
The next chart directly depicts the relationship (or the short-run lack thereof) between housing price growth changes and property tax revenue. Lags in changes in assessments and the ability of local governments to change property tax rates can go a long way in explaining why overall property tax revenue continues to grow.
Finally, Lutz, Molloy, and Shan broke down the data by some states, and I include the case of Georgia below. (The Ihlanfeldt and Doerner paper does something similar—and in great detail for the state of Florida.) The Georgia case clearly shows the effect of the lags: property values rose through the first part of the last decade and, even though tax rates were falling, overall tax revenue rose. Post-2007, however, market values of homes declined while the aggregate assessed values continued to rise through 2009 (along with property tax revenue).
It is hard to imagine the trend of aggregate increased assessed valuation continuing. If the assessed values begin to track the market values, pressures will emerge on the government entities that depend on property taxes. The picture suggests that tax rates and/or spending on programs are likely to change notably during the coming few years.
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March 11, 2009
Another side of the administration’s tax plan
While discussions of the Obama administration's tax plan focus on the expected impact on consumer spending and the federal deficit, not much attention has been given to the incentives of the plan for work effort. Different tax rates, deductions, and rebates provide varying degrees of incentives to work less or work more, and those incentives differ across income groups. Here I want to focus on just one of the proposed changes: the reinstatement of the 39.6 percent marginal tax rate for the wealthy.
Supply side economists tout low tax rates across the board as a way to provide incentives for people to work harder and thus for the economy to grow faster; with this thinking, people work harder because they get to keep more of the money they're working for.
Results in a recent working paper, with coauthor Robert Moore, confirm these predictions by finding that work effort increased across all income levels when tax rates were cut (among other things) in the 2001 Bush administration tax reform. But work effort increased much less among the more educated (higher income) families.
The administration's current budget plan includes a reversion of the marginal tax rate among the wealthiest to the pre-Bush tax rates—an increase from 35 to 39.6 percent. This tax rate increase is equivalent to reducing a worker's wage by 7 percent. The chart shows what the impact on work effort would be across education/income groups if wages were decreased for both groups by 7 percent; education and income are very highly correlated. The analysis found that husbands with a high school degree only would reduce their hours worked by about 63 hours per year (about 2.9 percent), whereas husbands with a college degree or more would reduce their work hours by only 42 hours per year (about 1.8 percent). Working wives in these families would also reduce their hours of work.
So, based on my research, if a need to raise some revenue means tax rates have to be increased for someone, raising them on the wealthiest will result in a smaller reduction in work effort than raising tax rates on the middle class.
The calculations here use results obtained from estimating a joint labor supply model for dual-earner families with different levels of education for the year 2000. A complete analysis of the work effort implications from the administration's tax plan would require accounting for all the changes to marginal tax rates, phase-outs of deductions, and tax credits simultaneously, as well as considering the impact on decisions of family members to enter or exit the labor market in response to the tax changes.
An additional relevant question remains: What is the implication of changing work effort for GDP growth? The relationship between work effort and value of output is not necessarily the same across income levels. In other words, one hour of high-income (higher education) labor is expected to yield a higher value of output in the economy than one hour of labor from a middle-income (lower education) worker. A complete analysis of the aggregate impact of the administration's tax plan would have to also take this into account.
By Julie Hotchkiss, research economist and policy adviser at the Atlanta Fed
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February 05, 2009
There is no accounting for priorities
Just in case you are desperately seeking some refuge from the pervasive blogland commentary on the fiscal stimulus proposal winding through the Senate (which already made its way through the House of Representatives), be forewarned: You won't find it here, but you will find an update to the old adage, There's no accounting for taste (de gustibus non est disputandum), which is to say that when it comes to the fiscal stimulus package, there's no accounting for priorities.
The Senate bill is not yet a done deal, of course, but a couple of clear differences between it and the House bill have emerged. According to the Congressional Budget Office—or CBO, from whom all figures in this post spring—the Senate bill is slightly bigger ($884.5 billion versus $819.5 billion) and would implement the stimulus at a faster pace. The current Senate bill would introduce about 79 percent of the expenditures and tax cuts in 2009 and 2010. The corresponding figure in the plan that came out of the House is 64 percent.
Perhaps more interesting—and maybe more confusing—are the priorities reflected in the separate bills:
The share of the stimulus devoted to discretionary spending—the place where, for example, infrastructure and education spending reside—is pretty similar in both stimulus plans (about 28 percent in the House version, about 26 percent in the Senate version). What is clearly different is the much greater reliance on tax cuts in the Senate bill, compared with the House bill's emphasis on "direct spending."
In a sense, this distinction is as much an issue of labeling as anything. The majority of the items in this category of direct spending are "provisions that would increase direct spending for unemployment insurance, health care, fiscal relief for states through the Medicaid program, and other programs," according to the CBO. In the language of economists and national income accountants these are "transfer payments," or funds that are transferred to individuals. Formally, they are subsidies for certain types of economic behavior—job seeking and purchasing health care, for example—and hence are really just a negative tax.
There is a certain arbitrariness to the distinction between increases in transfer payments and reductions in tax payments. This arbitrariness is illustrated by a change the CBO made between its initial assessment of the draft House bill and its (largely unchanged) summary of the bill that passed:
"The Congressional Budget Office, in consultation with JCT [Joint Committee on Taxation], has concluded that the subsidy for health insurance assistance for the unemployed should be treated as an increase in outlays rather than a decrease in revenues. Although this treatment is different from that in the table provided in our estimate for H.R. 1 as introduced on January 26, the overall effect on the budget remains the same for each year. JCT has also adjusted its estimates of the mix of revenue losses and outlay increases associated with certain refundable tax credits; that change also has no effect on the budget totals for each year."
Still, if you are likely to be on the receiving end of one of these programs, the distinction is probably not so arbitrary. From this end-user perspective, there is an important economic distinction between approaches taken in the competing plans. So then, which approach to "tax cuts" is better? At this point, I will send you to the aforementioned pervasive blogland commentary. You will find no shortage of opinions.
By David Altig, senior vice president and research director at the Atlanta Fed
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January 07, 2009
Will tax stimulus stimulate investment?
Update: Reader Doug Lee points out that the fixed investment series above is dominated by the extraordinary decline in residential investment over the past several years. For that sector, the questions posed above are in a bit sharper focus. Are firms in the residential investment sector pessimistic about future prospects? Absolutely. Are compromised credit markets behind the low investment levels? Quite possibly, though given the large inventory overhang in housing it is improbable that activity in the sector would be robust in any case. Is the low investment/net worth ratio symptomatic of a general deleveraging within the nonfinancial business sector? Not so clear, as it is pretty hard to see through the effect in residential category.
Here, then is a chart of the history of nonresidential fixed investment relative to corporate net worth:
The recent decline in the ratio, while still there, is much less dramatic and, in fact, seems to be part of a more persistent trend that commenced prior to the 2001 recession (and which may have been temporarily disguised by the housing boom that followed).
Was the nonfinancial nonresidential business sector ahead in the deleveraging game—ahead of residential construction businesses, financial firms, and consumers? And could this bode well for this sector when the recovery begins? Unfortunately, I have more questions than answers.
By David Altig, senior vice president and research director at the Atlanta Fed
On Monday, the form of potential fiscal stimulus, 2009-style, took a step forward detail-wise. From the Wall Street Journal:
“President-elect Barack Obama and congressional Democrats are crafting a plan to offer about $300 billion of tax cuts to individuals and businesses, a move aimed at attracting Republican support for an economic-stimulus package and prodding companies to create jobs.
“The size of the proposed tax cuts—which would account for about 40% of a stimulus package that could reach $775 billion over two years—is greater than many on both sides of the aisle in Congress had anticipated.”
The plan appears to make concessions to both economic theory—which suggests that consumers will save a relatively large fraction of temporary increases in disposable income—and recent experience—which seems to suggest that what works in theory sometimes works in practice. Again, from the Wall Street Journal:
“Economists of all political stripes widely agree the checks sent out last spring were ineffective in stemming the economic slide, partly because many strapped consumers paid bills or saved the cash rather than spend it. But Obama aides wanted a provision that could get money into consumers’ hands fast, and hope they will be persuaded to spend money this time if the credit is made a permanent feature of the tax code.”
As for the business tax package:
“… a key provision would allow companies to write off huge losses incurred last year, as well as any losses from 2009, to retroactively reduce tax bills dating back five years. Obama aides note that businesses would have been able to claim most of the tax write-offs on future tax returns, and the proposal simply accelerates those write-offs to make them available in the current tax season, when a lack of available credit is leaving many companies short of cash.
“A second provision would entice firms to plow that money back into new investment. The write-offs would be retroactive to expenditures made as of Jan. 1, 2009, to ensure that companies don’t sit on their money until after Congress passes the measure.”
A relevant question here is really quite similar to the one we ask when the tax cuts are aimed at households: Will the extra cash be spent? This graph provides some interesting perspective:
Relative to net worth (of nonfarm nonfinancial corporate businesses), private fixed investment has been in consistent decline since the second quarter of 2006. (The level of fixed investment has declined in each quarter, save one.) In fact, the investment/net worth ratio is currently at a postwar low.
Why? A couple of hypotheses come to mind. (1) Firms are extremely pessimistic about the outlook and see relatively few worthwhile projects in which to commit funds. (2) Credit markets are so impaired that the net worth of firms—a critical variable in mainstream models of the so-called “credit channel” of monetary policy—is supporting increasingly smaller levels of lending. (3) Nonfinancial firms, like financial firms, are deleveraging and hence not expanding.
Of course, even if one of these hypotheses is true, it need not be the case that marginal dollars sent in the direction of businesses will go uninvested. But it makes you wonder.
By David Altig, senior vice president and research director at the Atlanta Fed
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