Dynamic Estimates of the Macroeconomic Effects of the House Republican Tax Reform Blueprint
Table of Contents
Author(s)
John W. Diamond
Edward A. and Hermena Hancock Kelly Fellow in Public Finance | Director, Center for Public FinanceGeorge R. Zodrow
Baker Institute Rice Faculty Scholar | Allyn R. and Gladys M. Cline Chair of EconomicsExecutive Summary
In response to widespread concerns that the income tax system in the United States is highly inefficient, unfair, unnecessarily complicated, and discourages economic growth while putting US multinational companies at a disadvantage relative to their foreign competitors, numerous proposals for sweeping reforms have been advanced in recent years. In June 2016, House Speaker Paul Ryan (R-WI) and Rep. Kevin Brady (R-TX), Chair of the House Ways and Means Committee, put forth a blueprint for tax reform commonly referred to as the House Republican Tax Plan (HRTP), a proposal that would dramatically change the taxation of business income in the United States and implement significant changes of the individual income tax as well. In particular, the HRTP would reduce business tax rates dramatically, tax businesses on a cash-flow basis (allowing expensing rather than deductions for depreciation and eliminating deductions for the interest on debt-financed investment), and introduce a destination-based territorial business tax that would include new “border adjustments” – the element of the proposal that has generated the most controversy. The border adjustments would deny business deductions for imported production inputs, apply tax to imported consumer goods, and exclude from the cash flow tax base all receipts from export sales. Individual income tax rates on both labor and capital income would also be lowered, coupled with increases in standard deductions, the elimination of personal exemptions, and the elimination of various deductions, exemptions, and other tax preferences.
Such proposals have a broad range of complex and interacting effects on the performance of the US economy. One commonly used way to investigate the net results of many of these interactions, including their dynamic effects on economic growth and other macroeconomic variables, is to simulate them within the context of a dynamic computable general equilibrium model. In this report, we present the results of such a simulation, using the Diamond and Zodrow Model.
As has been widely reported, the HRTP is not a revenue neutral reform. We assume that the deficits that arise under HRTP – taking into account the dynamic effects of the reform on revenues – are offset with additional government borrowing for the first ten years after enactment of the reform. This increases the debt-GDP ratio in the economy, which remains constant at a higher level beginning in the eleventh year after reform. The government is then assumed to balance its annual budget with changes in total transfer payments, which initially decline and then increase. The simulation results suggest that the net macroeconomic effects of enacting the HRTP would be positive, with an increase in GDP of 1.8 percent ten years after the enactment of reform and 3.3 percent in the long run. These increases are attributable to many factors, including an increase in domestic investment, a reallocation of firm-specific capital that earns above normal economic rents to the United States, and a sizable reversal of income shifting, as well as modest increases in labor supply and larger increases in labor compensation. These results suggest that enactment of the HRTP would have positive net effects on the macroeconomic performance of the US economy.