What’s Ahead for the U.S. Economy?

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The U.S. economy seems stuck in neutral for the near term as the numbers of new COVID-19 cases reach new highs in nearly all states, although President-elect Joe Biden’s proposals could bring relief on several fronts, according to a recent post-election press briefing held by the Penn Wharton Budget Model (PWBM) on November 12. The PWBM is a nonpartisan research organization that provides economic analysis of the fiscal impact of public policy.

The implications of the unrelenting pandemic were at the top of the agenda during the briefing. “R,” or the effective reproduction number to measure secondary infections, is currently racing as if one’s foot were “on the gas pedal,” noted John Ricco, senior analyst at PWBM.

“When your R is bigger than 1, you get explosive growth,” Ricco said. “Our analysis shows that the number of states where R is greater than 1 — in that danger zone — is almost near 50 right now. It’s a pretty dire situation.”

In addition to monthly or quarterly government data, the PWBM team developed its own “high-frequency economic trackers” including data on Google searches for unemployment claims and cell phone location data to “track how the recovery is going on in real time,” said Ricco. For instance, it found a plateauing of the “social contact rate,” or how frequently people come together in close physical contact, which is a desirable trend. But that trend also puts an upper limit on the recovery, and employment trends reflect that, he added. “We’re basically stuck in neutral right here until the virus is suppressed.”

In the near term, regarding non-pharmaceutical interventions, the stress ought to be on getting right individual behavior to contain the spread of the pandemic, Ricco said. “Beyond that, the recovery will depend on what happens in six months or so with the vaccine, and any fiscal response.”

Parsing the Biden Plan

In a study of the proposals by President-elect Joe Biden, PWBM found that over the 10-year budget window of 2021–2030, the Biden platform would raise $3.375 trillion in additional tax revenue and increase spending by $5.37 trillion. Including macroeconomic and health effects, by 2050 the Biden platform would decrease the federal debt by 6.1% and increase GDP by 0.8% relative to estimates under current law. But in the run-up to 2050, GDP decreases by 0.4% in 2030, and stays flat in 2040, the study noted.

“The recovery will depend on what happens in six months or so with the vaccine, and any fiscal response.” –John Ricco

GDP growth dips in the near term because of some distorting effects of changes to the tax system and in health care benefits, said Kent Smetters, PWBM’s faculty director, who is also Wharton professor of business economics and public policy. As higher tax rates hurt high-income people more under the Biden plan, they end up dampening capital investments. But “as people get greater access to health care, there’s little less pressure on them to work,” said Smetters. “That means labor becomes a scarcer as they have fewer workers, and hourly wages actually go up.”

Over a 10-year period, the largest new revenue-raisers in the Biden tax plan are the corporate tax ($1.4 trillion), payroll taxes ($992.8 billion) and individual income taxes ($944 billion). Over that same period, the two biggest areas of new net spending would be education ($1.9 trillion) and infrastructure and R&D ($1.6 trillion). Housing, social security benefits, health care and expanded paid leave are the other spending areas.

The study noted that most provisions of the Biden tax plan focus on raising taxes on corporations, capital income, and ordinary income of high-income filers. Two major provisions of the Biden proposals are (a) implement a Social Security “Donut Hole,” or a band of non-taxable wages between the current annual taxable maximum threshold of $137,700 and $400,000 for the 12.4% payroll tax that finances the Social Security Trust fund; and (b) repeal elements of the Tax Cuts and Jobs Act (TCJA) for high-income filers.

Previous PWBM studies have analyzed those and other features of the Biden plan, including raising the corporate tax rate, taxation of capital gains and dividends at ordinary rates, limiting itemized deductions, and eliminating fossil fuel subsidies.

Who Gains, Who Loses

One PWBM chart traces the impact on individuals by age group and adjusted gross income, which shows “who would prefer to live in a Biden world,” said Richard Prisinzano, PWBM’s director of policy analysis. “It’s the older rich people that don’t like Biden’s world,” he noted. “They face a lot of taxes, and they don’t get a lot of benefits from the spending program. At the other end, the lower-income folks really do like Biden’s world.”

In calculating the impact at the individual level, PWBM used a dynamic model that covers entire lifetimes, compared to conventional models that look at tax changes only in one year. It found that in a Biden regime, working-age and lower-income people benefit, whereas higher-income young workers and wealthy retirees lose. Almost 80% of the increase in taxes under the Biden tax plan would fall on the top 1% of the income distribution.

“It’s the older rich people that don’t like Biden’s world. They face a lot of taxes, and they don’t get a lot of benefits from the spending program.” –Richard Prisinzano

Under the Biden tax plan, households with adjusted gross income (AGI) of $400,000 per year or less would not see their taxes increase directly but would see lower investment returns and wages as a result of corporate tax increases, the PWBM study found. Those with AGIs at or below $400,000 would see an average decrease in after-tax income of 0.9%. But after-tax incomes would fall by 17.7% for those with AGIs of more than $400,000, who make up the top 1.5% of taxpayers.

In distributing the corporate income tax to households, PWBM assumed that 75% of the tax falls on capital owners and 25% falls on workers in the form of lower wages over time. These lower wages and lower investment returns are included in its calculation of the “effective tax rate.” That rate stays mostly unchanged between current law and the Biden plan for all but the top 0.1% of households, who will experience a bump from 30.6% to 43% if the tax changes are implemented in 2021.

Where the Money Will Be Spent

The PWBM study grouped the new public investments in the Biden plan into three categories: education, infrastructure and R&D.

The education plan, which will boost spending by $1.9 trillion over 10 years, includes provisions for universal pre-K schooling, two years of debtless college education and free public college for students from low-income families. The infrastructure and R&D plans totaling $1.6 trillion cover investments in water infrastructure, high-speed rail, clean energy R&D, 5G and artificial intelligence.

The study expected every dollar of new federal spending to stimulate an additional 62 cents from state and local governments for every dollar. PWBM has modeled each of those public investment categories as boosting the productivity of both private capital and workers, thus increasing wages, interest rates and GDP.

PWBM noted that other areas that will see new spending in the Biden plan, over 10 years, are housing ($650 billion), social security ($290.7 billion) and health care ($352 billion). In health care, the study estimated that Biden’s proposals would lower average prescription drug prices by about 60%, by allowing consumers to import those drugs from abroad and for Medicare to negotiate prices.

Biden’s plan to ease immigration policies will take time to reverse the historically low levels to which immigration had fallen in the Trump regime. The pandemic will stifle immigration, and it will return slowly to historical levels only by 2050, the PWBM study predicted.

“If one were to do a stimulus, certainly doing it today is going to be more effective than waiting a while.” –Kent Smetters

The Immigration Booster

Biden’s immigration plans will see distinct outcomes on several fronts. Granting legal status to undocumented immigrants will reduce emigration rates as documented immigrants emigrate back to their countries less often than those that are undocumented, the study noted. Furthermore, “fertility increases since immigrants have more children, and this increase, in turn, has downstream demographic and economic effects such as a slightly younger population.”

With friendlier immigration policies, “the pie gets bigger … and it builds up the economy in a general sense,” said Prisinzano. He noted that such policies attract “high-ability people” who contribute to patents, boost productivity levels and GDP growth.

All said, “a lot of the economy is still based on what happens with the pandemic,” said Prisinzano. But there are no easy options for policymakers. “There are benefits in trying to keep some of the businesses that are struggling. There’s also a benefit to not doing anything that would encourage people to do unsafe things like go out in the economy and try to do things.”

Smetters noted that some of the recent surge in economic activity is because of the increase in social contact rates. “That could also lead to more shutdowns, and it could rebound and drag things in the opposite direction. It’s really hard to have a simple story behind it, because a lot of this has to do with people’s perceptions.”

Another round of economic stimulus is certainly something that policymakers are considering. The PWBM does not make policy recommendations, Smetters said as a disclaimer before noting, “If one were to do a stimulus, certainly doing it today is going to be more effective than waiting a while.” A stimulus focused on lower-income people who are more likely to consume that money will prove more effective than if it is targeted at others who are less likely to consume, and instead save that money, he added.

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