Kimberly Burham of the Penn Wharton Budget Model looks under the hood of the House version of tax reform.

With potential tax reforms moving very quickly through the hoops in Washington, D.C., Knowledge at Wharton has invited Kimberly Burham back to help explain the latest one — the House of Representatives’ version of a new tax regime. Burham is managing director of legislation and special projects for the Penn Wharton Budget Model, a rich economic simulator that can be used interactively online to calculate how various tax policies would affect such things as budget deficits, GDP, employment and the like. So far, both the House version and the only partially fleshed-out Senate version of proposed tax reform increase the federal deficit — neither pay for themselves through added economic stimulus as some proponents contend, according to the Penn Wharton Budget Model. What’s more, there is not much effect from either version on the progressiveness of the tax code.  Notes Burham: “The tax bill is not being shifted lower down the income distribution. It is being maintained.”

An edited version of the conversation appears below:

Knowledge at Wharton: Kimberly, you earlier looked at the static budget model that had been released recently, and now the House has released its version. We will also have the full Senate version shortly. Would you please give us an overview of what the big tax changes are in the House bill, which could be voted on very soon?

Kimberly Burham: One of the big things is that rather than keeping seven income tax brackets for individuals, they are narrowing that down to four. The other big thing is that they are doubling, roughly, the standard deduction while repealing personal exemptions. And they are also expanding the child tax credit and repealing a lot of itemized deductions. On the business side, they are also repealing a lot of tax expenditures, deductions and credits, but they are really lowering the rates. There, they are going down to a 20% tax rate on corporations, and then for pass-throughs a top rate of 25%. So there are a lot of tax cuts, and they are trying to pay for them by broadening the base.

Knowledge at Wharton: What happens to debt under your model?

Burham: Our dynamic analysis shows that over 10 years, it increases federal debt somewhere between $2 trillion and $2.1 trillion. By 2040, debt will increase from somewhere between $6.3 trillion and $6.8 trillion more than it would under current policy. Overall, both tax bills are a tax cut — taking revenue out of the system.

Knowledge at Wharton: You have just described debt. What would happen to economic growth?

Burham: The tricky thing about debt is that as you increase debt in the long run, it actually dampens economic growth, and that’s because some of the savings that people have don’t go into private investment – they go into paying for the debt. As a result, after 10 years, the tax cut and jobs act will increase GDP somewhere between 0.33% and 0.83% relative to where it would have been in 2027. However, this boost fades over time, mostly due to the rising debt. And by 2040, GDP could even fall below, in some scenarios, the current policy GDP.

Knowledge at Wharton: What does analysis by other groups show?

Burham: There are a lot of other groups that produce similar analysis. There is the Congressional Budget Office, which is the official score-keeper. There are a few other groups out there and they are sometimes similar, sometimes different from us. In addition, it matters for these dynamic models what parameters and assumptions that you are making. In particular, there are two key parameters. One is the assumptions that you make about the return to capital. And you could think that as the return to capital, you could set it at something like the return to the S&P — a relatively high rate of return.

“The tax cuts do not fully pay for themselves.”

Alternatively, you could set it a bit lower  — at the risk-free rate of return. We think that probably the lower setting is a little more realistic in the long run. However, everyone can decide what they think [by plugging in numbers they prefer into the online simulator]. When you take one of these models and assume a high rate of return — that really increases investment, which fuels growth. And therefore, you find more growth and less debt, because the tax cuts appear to pay more for themselves.

The other [key assumption] is the openness of the economy, the international capital flows, which are related to trade as well. So in that model, debt doesn’t matter because every time the government issues it, a bunch of foreign dollars flow in. You have to think about that in terms of [the question] does some other country own the United States? Do they own more and more and more of the assets of the country? And there are effects on trade.

Knowledge at Wharton: Do the tax cuts that are proposed in the House plan pay for themselves? Who gains from the tax changes — which income group?

Burham: In fact, they don’t fully pay for themselves. We do see over the 10-year period that we can make up for about $500 billion with the dynamic model. But overall, they’re still adding to the debt and increasing deficits over that period.

[Regarding winners and losers,] there are two ways to look at it. One way is that you could think about who is getting most of these benefits. And in that case, most of the tax cuts are accruing to upper-income households. But the other question is: What’s happening to progressivity [of the tax code] over the whole system? That is, [which income groups] pay what share of the entire federal tax bill? We find that it is surprisingly stable. For instance, in 2018, with no tax bill, people in the top 10% of the income distribution will pay 28% of total taxes.

Meanwhile, under the Tax Cut and Jobs Act, they would pay 27%. So those numbers are pretty close. In addition, even if you go far out all the way to 2040, the difference they would pay is 30% if we did not change the tax system, and the top 1% would pay 28% if we did change the tax system. It is surprising that there is not a larger effect on progressivity, but it’s pretty stable.

Knowledge at Wharton: Does that mean that things aren’t changing down the line that much, either, if things aren’t changing at the top that much, when it comes to progressivity?

“The tax bill is not being shifted lower down the income distribution. It is being maintained.”

Burham: Yes, that does mean that basically the tax bill is not being shifted lower down the income distribution. It is being maintained.

Knowledge at Wharton: This House bill could be voted on very soon. At the same time, the Senate is going to be releasing their full bill soon. They’ve released some highlights, but not all the detail that you would need to run a good model. But can you tell us something about the difference between the House version and the Senate version?

Burham: Sure. So the House version, for individuals, goes from seven brackets down to four. The Senate bill keeps the seven-bracket system. They do change some of their rates. For instance, the top rate will go from 39.6% to 38.5%. Like the House, the Senate bill also roughly doubles the standard deduction and repeals personal exemptions. Moreover, the Senate bill expands the child tax credit even further, so that more of it will be refundable than under the House bill. On the business side, they also go down to a 20% rate on corporations. However, they do not start that until 2019, so they delay that by a year. And the other thing they do on the business side is approach pass-through companies a little bit differently, so the House side has a 25% pass-through rate, and the Senate instead allows them a 17.4% deduction to lower the taxes for pass-through businesses.