A promise for the most far-reaching tax reform in 30 years by President Trump and Congressional Republicans is creating more questions than answers. Early proposals have put forth mostly broad ideas of principle that lack enough of the nitty-gritty details needed to calculate true bottom-line effects, particularly given the many political trade-offs among competing groups still to come. Still, it is possible to glean at least one key conclusion, says Kimberly Burham, managing director of legislation and special projects for the Penn Wharton Budget Model [PWBM]: The tax cuts as initially envisioned will not pay for themselves through increased economic growth, and over 10 years will likely add more than the promised $1.5 trillion to federal debt. Burham discussed this and other implications of the tax bill as it is understood thus far in this Knowledge at Wharton podcast. [Here is the PWBM’s latest report on the tax bill].
An edited transcript of the conversation follows.
Knowledge at Wharton: I’d like to welcome Kimberly Burham to Knowledge at Wharton. She is the managing director of legislation and special projects for the Penn Wharton Budget Model, a highly detailed economic simulator that can be used interactively online for free to change any tax policies and figure out how those changes would affect not just the federal budget, but GDP and more.
We’re here to talk about the new tax legislation or reforms that have been put forth by the Trump administration and the Republican leadership. They are perhaps the most sweeping changes in 30 years. There’s a lot of detail left out of the broad plan so far, so a lot will be left to legislators to determine. Nevertheless, we’d like to get an idea of what effects the proposals would have on things like the budget, the middle class, GDP and labor and income.
Burham: We took a look at three different options. And there really is a lot of room for policymakers within this new proposal to make decisions. And those decisions are going to have big impacts on the deficit and GDP and wages. So for instance, within this proposal, among the three options, one option would increase the deficit by more than $10 trillion in 2040. But another option would only increase it by $2 trillion. So there’s a huge amount of room here for policymakers to make decisions that are going to matter…. For instance, in our sort of most rosy option, Option C, in the static sense, it would increase the deficit in 10 years by $1.5 trillion, but once we account for these feedback effects, which is allowing people to adjust how they consume, how they save, how they work, then it only increases the deficit by $1 trillion.
Knowledge at Wharton: Is there a way to characterize one of the big questions, which is how it might affect the middle class?
“These particular sets of tax cuts are not fully paying for themselves…. [They are] increasing the deficit, both in the short and long run.”
Burham: We do know that all of our options do lead to a small amount of increase in labor income and GDP. And we do model increasing the Child Tax Credit, both by introducing a new $500 credit for non-child dependents and, in some of our scenarios, by increasing the value of the credit to $1,500 and increasing the number of people that can reach. That’s a policy that can really reach a broad swath of the American public, and that could help a lot of people.
Knowledge at Wharton: It sounds like, in the end, what you’re saying is that the devil’s in the details, and it’s difficult right now to say what the exact effects will be, because we don’t have enough detail.
Burham: I think that’s true. There’s just a large swath of outcomes that are possible. It’s going to be really hard to tell, at this point, who is going to be helped and who is maybe going to be hurt by tax reform.
Knowledge at Wharton: But as these details are revealed and get plugged into the model, the model will be very robust in determining the effects?
Burham: Yes. We’ll be introducing some distributional analysis soon, as well as taking a look at any bill that comes out of the Senate or the House.
Knowledge at Wharton: But in a broad sense, can you talk about effects on GDP, for example?
Burham: Right. That also has a broad swath of capabilities. Say, for GDP in 2027: Under Option A — which is sort of the more expensive option — it assumes that a lot of the base broadening or tax expenditures do not get repealed in the bill. That would increase [total] GDP of 2027 by 1.4%.
And then on the other hand, if you assume that those do [get repealed], then GDP would increase by 1.3% — which sounds like not a lot of difference, but when we’re talking GDP, you’re talking big, huge numbers, trillions of dollars. So that does make a difference…. This isn’t growth rates, this is just on [an increase in the] base….
And the effects differ in the long run…. So in between when you look at 2040, then in between Option A, which again assumes that we don’t get rid of a lot of the tax deductions, et cetera, then GDP would be 1% higher than under current policy. On the other hand, if we can get rid of a lot of those tax expenditures and deductions, then GDP would actually be 2.3% higher than current policy. That would be a huge amount of growth, if that happens.
Knowledge at Wharton: What does the model have to say at this point about changes in corporate taxation? Because there are a lot of proposals there.
Burham: We assumed that the corporate tax rate will go down to 20% with no corporate alternative minimum tax. And then we also assumed that the pass-through rate will drop down to 25%, and that people will be able to make appropriate decisions. So we take into account, as far as the pass-through tax rate, income shifting and conversion in between different types of businesses and corporations, as well as in between individual and business income.
Knowledge at Wharton: Can you explain the pass-through rate for our listeners?
Burham: Sure. Right now, there are these businesses called pass-through businesses, because the income passes through them and is then taxed at the individual rate.
Knowledge at Wharton: So this is like the S Corporations and it affects mostly small and medium-sized businesses, largely?
Burham: Right. S Corps, partnerships, sole proprietorships — those types of businesses, for which in our model [the tax rate] would be 20%….
In the new proposal, the pass-through rate, because it is currently passed through onto individual income taxes, would face a top rate of 25%. And so it’s possible for people there, because many of those are self-employed businesses, to characterize their income as either individual or as business. And so we take into account the ability of people to characterize their income differently, and for businesses to decide if they want to be a C Corporation or a pass-through business.
“Under this unified framework, they’re doubling the standard deduction. And that could really help a lot of Americans. On the other hand, they’re getting rid of personal exemptions.”
Knowledge at Wharton: Is there a way to say that, based on the broad strokes that we know now … how does that compare with what you’re finding?
Burham: One of the things that we’re seeing is, when people talk about tax cuts paying for themselves — and our model does account for that by allowing people to change how they save and consume and how they work in response to the policy change — what we’re seeing is that these particular sets of tax cuts are not fully paying for themselves. And you can tell that because [they are] increasing the deficit, both in the short and long run.
Knowledge at Wharton: That’s a major point. And as far as the distribution among different income brackets, you’re saying that you don’t really have enough detail right now [based on the preliminary proposals] to make a judgment on how that matches up against claims and counter-claims.
Burham: Right. And I think the devil will be in the details in that case. So for instance, under this unified framework, they’re doubling the standard deduction. And that could really help a lot of Americans. On the other hand, they’re getting rid of personal exemptions. And for some people that have a lot of dependents, large families, that pairing of those two, they could wind up hurt by that proposal.
Knowledge at Wharton: So you can run the simulation and say what it means right now. But in the end, there’s going to be a lot of haggling. And if one or two things which happen to have a big effect are left out or kept in, it can really change the numbers.
Burham: Right. Like, in our Option C, what our goal there was, in the budgets that were passed in the House and the Senate, they’re allowed to increase the deficit on a ten-year basis by $1.5 trillion. And in order to achieve that, we actually had to increase the corporate business rates a little bit. For instance, instead of modeling a 20% corporate rate, we modeled a 25% rate. And instead of modeling a 25% pass through-rate, we modeled a 28% pass-through rate, just to get them within that $1.5 trillion deficit increase.
Knowledge at Wharton: To hold the deficit down.
Knowledge at Wharton: It sounds like as more details are released, it might be interesting for some of our listeners to go online and plug in some numbers themselves and give this thing a test drive.
Burham: We have simulators, and you can take a look both at what the unified framework would be, and then you can change and adjust that and see how you would try to balance the budget.
You can learn more about the Penn Wharton Budget Model and simulate the effects of various tax policies at budgetmodel.wharton.upenn.edu.