Alex Arnon from Penn Wharton Budget Model speaks with Wharton Business Daily on SiriusXM about the budgetary and macroeconomic effects of Biden’s American Jobs Plan.

The American Jobs Plan (AJP) proposed by President Biden on March 31 would spend $2.7 trillion and raise $2.1 trillion dollars over the 10-year budget window of 2022–2031, according to the Penn Wharton Budget Model (PWBM), a nonpartisan initiative that analyzes the economic impact of public policy proposals.

The AJP’s tax and spending provisions would increase government debt by 1.7% and reduce GDP by a quarter percentage point by 2031, the study projected. By 2050, however, government debt would fall by 6.4% and GDP would decrease by 0.8%, according to its estimates.

“The decline in GDP isn’t necessarily going to mean that we are worse off as a society,” Alex Arnon, associate director of policy analysis at PWBM, said in an interview on the Wharton Business Daily radio show on SiriusXM. (Listen to the podcast at the top of this page). Much of the spending is to keep existing infrastructure in running condition and to provide insurance against unforeseen setbacks, he added.

“A lot of the investments [will be] in resilience, and as a form of insurance against, say, catastrophic climate change or a future pandemic,” Arnon continued. “Those investments in the most likely outcome don’t pay out in full [if] things go okay. But if we get unlucky and things turn out much worse than we expect, we’ll be glad we have that insurance.” Some benefits of those investments are not captured in GDP measurements, such as “better roads, safer and faster trains, or more regular bus services,” he added.

Taking the Long View

While the AJP does not specify any spending plans beyond 2029, PWBM has assumed that the proposal would not increase federal outlays in 2030 and beyond, and that its business tax provisions continue past the budget window.

The study assessed the impacts beyond the 10-year budget window, extending up to 2050, in order to remove the “big bias” that a shorter window would entail, PWBM faculty director Kent Smetters said at a press conference where he released the study’s findings. The estimates “would not look favorable” in a 10-year window, especially since public spending on infrastructure projects such as bridges would have “a longer-run path” before they begin to pay off, said Smetters, who is also a Wharton professor of business economics and public policy. “We want to give a fairer comparison by going more long-run.” Smetters is

In addition to Arnon, the PWBM team that conducted the analysis includes Marcos Dinerstein, economist; Jon Huntley, senior economist; and John Ricco, associate director of policy analysis, under the direction of Richard Prisinzano, director of policy analysis and Efraim Berkovich, director of computational dynamics.

“The fact that we are pulling resources out of the private sector in order to make these investments in public capital [will hurt] future outputs.” –Alex Arnon

Funding for the AJP is planned from higher business taxes, including an increase in the corporate tax rate to 28%; a minimum tax on corporate book income (income firms publicly report on financial statements); and a higher tax rate on foreign profits of U.S. companies. Other funding is planned by removing tax preferences for fossil fuels and tax deductions for certain types of foreign income.

The original Biden campaign proposal called for spending on public infrastructure, R&D, workforce training, affordable housing, and caregiving. It later added an additional $400 billion in clean energy tax credits.

The PWBM model treated individual components of those spending outlays as either public investments or as transfers. Public investments, totaling $2.1 trillion of the AJP, include new spending on transit infrastructure, R&D, and domestic manufacturing supply chains. Investments in such “public capital” enhance the productivity of private capital and labor. Transfers, totaling $600 billion, include spending on affordable housing access and on home- and community-based care.

Crowding out Private Investment

New spending on either public investments or transfers, if financed through increased federal deficits, has the indirect effect of crowding out private investment. “That crowding-out effect reduces growth in the capital stock and thus GDP,” the study noted.

According to PWBM, the tax provisions in the AJP have two direct economic effects: decreasing firms’ incentives to invest and disincentivizing saving by households. “The revenue raised by these tax provisions has the indirect effect of decreasing government deficits and thus crowding in private investment,” it stated.

“In isolation, raising the statutory corporate tax rate is expected to increase corporate investment in the near term. However, that positive effect is reversed when an increase to the corporate rate is combined with the AJP’s proposed minimum tax on book income, which reduces the value of depreciation deductions — in turn increasing the tax wedge on investment. The plan’s international tax provisions also increase the overall tax burden on corporate income.”

Those tax provisions have a cascading effect: The increase in corporate tax rates lowers the after-tax return on equity investment, the study noted. As a result, “households, facing lower after-tax returns, save less which in turn decreases investment and the capital stock.”

“The fact that we are pulling resources out of the private sector in order to make these investments in public capital [will hurt] future outputs,” Arnon said. “The tax increases fall [almost] entirely on corporations, and they are a significant negative for investment and therefore for economic growth over the long run.”

Although the plan’s public investments increase the productivity of capital and labor, that productivity boost is not enough to overcome additional crowding out of capital due to increased government deficits, PWBM stated. By 2031, the AJP’s spending provisions alone would increase government debt by 8.16%, and decrease capital stock by 1.17%, and GDP by 0.25%. By 2050, all of those would fall: government debt by 4.72%, capital stock by 1.46% GDP by 0.33%.

Those funding estimates are on the conservative side because PWBM did not measure the potential impact of other tax proposals in the AJP. They include increased tax enforcement against corporations, denial of expensing for offshoring jobs, and the creation of a tax credit for onshoring jobs. The Biden administration also plans to push other countries to increase their corporate taxes.

Backtracking on Minimum Corporate Tax

The AJP includes a new form of minimum tax based on book income, but with some modifications. That is in sharp contrast to the 2017 Tax Cuts and Jobs Act, which repealed the corporate alternative minimum tax.

Some of the motivation there for the Biden administration might be to target corporations that may over-report book income, or what they publicly report, to attract investors, while underreporting taxable income to lower their taxes, said Arnon. “It’s trying to balance those incentives. The thinking is it will encourage corporations to be more accurate in their reporting of both incomes.”

Compared to the corporate minimum tax requirements that existed prior to the Tax Cuts and Jobs Act, the AJP proposal “is even more complicated and creates even more strange incentives,” Arnon noted.

Treasury secretary Janet Yellen last week also called for a global minimum corporate tax rate to prevent corporations from fleeing to lower-tax or tax-free regimes. Such a global tax could help prevent the type of “race to the bottom” that has been underway, Yellen said in a speech to the Chicago Council on Global Affairs.

“[The AJP is] much more aggressive in terms of seeking out and making sure we tax every dollar of corporate profits, regardless of where it’s earned.” –Alex Arnon

Taxing Foreign Income

The AJP’s proposal to collect more taxes on the foreign profits of U.S. corporations represents “a huge change” from the existing tax regime, said Arnon. He noted that while the Tax Cuts and Jobs Act “massively overhauled the system of international taxation,” the Biden administration wants to scrap all of that and replace it with a new system. “[The AJP is] much more aggressive in terms of seeking out and making sure we tax every dollar of corporate profits, regardless of where it’s earned.”

Taxing foreign profits of U.S. corporations could backfire by prompting them to either relocate overseas, get acquired by a foreign company, or do inversions. “This is probably the single biggest uncertainty in what the plan would actually end up doing,” said Arnon. “The proposed new taxation of foreign profits increases the incentive [for a U.S. corporation] to complete an inversion [by getting] acquired by a foreign corporation [in a lower-tax country].” Taxing foreign profits would increase the value of an inversion for a corporation with substantial international operations, he added.

The Biden administration plans to prevent those inversions with penalties for corporations that go headquarters shopping overseas. “They will use regulatory means, essentially, to ensure that corporations cannot just ditch the U.S. purely for tax reasons,” said Arnon. He recalled that after “a wave of inversions in the mid-2000s,” new rules put in place by the Obama administration and the Tax Cuts and Jobs Act “dramatically reduced the incentives to invert, and we did see a significant slowdown in inversions.”

“Those inversions all but ended after 2017 as reform lowered the top corporate rate to 21% from 35% and moved the U.S. closer to a territorial tax system in which income is taxed where it is earned,” The Wall Street Journal said in an editorial, citing research by Dan Clifton of Strategas Research Partners. In the three years after the passage of the Tax Cuts and Jobs Act (2018–2020), companies repatriated $1.6 trillion from overseas to the U.S., a sharp increase from the $495 billion repatriated in the three years prior to the tax cuts, the data showed.

Those tax provisions have a cascading effect: The increase in corporate tax rates lowers the after-tax return on equity investment, the study noted. As a result, “households, facing lower after-tax returns, save less which in turn decreases investment and the capital stock,” the PWBM report noted.

“Despite the decline in government debt, the investment-disincentivizing effects of the AJP’s business tax provisions decrease the capital stock by 3% in 2031 and 2050,” the study stated. “The decline in capital makes workers less productive despite the increase in productivity due to more infrastructure, dragging hourly wages down by 0.7% in 2031 and 0.8% in 2050.”

Put another way, that means “workers will have less capital to work with and less high technology because of the negative effect on investment,” said Arnon.

Not an Easy Passage

With its controversial proposals, the AJP is expected to face challenges as it makes its way through Congress. “We can already see different groups lining up to take aim at specific provisions,” Arnon noted. “I fully expect that if we do see any kind of final legislation, it’s not going to look exactly like this.”

The AJP is a work-in-progress, and its final shape would depend on the challenges it faces in Congress and modifications the Biden administration may incorporate. One big change came on April 8, when PWBM’s release of its study coincided with a report in The Wall Street Journal that the Biden administration plans to raise the income threshold for its proposed minimum corporate tax to $2 billion from its campaign proposal of $100 million. “The change will lose revenue and increase short-term deficits,” said Smetters. PWBM will assess the potential impact in future studies, he added.