February 21, 2001 | Commentary on Taxes
How much would President Bush's tax-cut plan actually reduce taxes? He says $1.6 trillion over 10 years. Some congressional opponents claim it would be more than $2 trillion. The Washington Post says it would "likely consume or exceed the available budget surplus." You know what that means: no more debt repayment, no Social Security or Medicare reform, and a return to deficit spending. Right?
Not so fast. Such a pessimistic scenario is possible only if you ignore the way the economy works and use what is known as a "static" economic model-one that assumes taxpayers will behave exactly the same after a tax cut as they did before. Static estimates don't account for predictable changes in consumer and business spending. They act as if interest rates, employment, personal income, savings and inflation will remain-well, static.
But such an assumption is absurd. Americans have always modified their economic activities in response to tax cuts. The reactions to the 1963 Kennedy tax cut and the 1981 Reagan tax cut prove it conclusively.
The only sensible way to analyze a tax-cut plan is to use what economists call a "dynamic" model that incorporates realistic predictions about what consumers and business owners will do once their taxes are cut. That's what we in The Heritage Foundation's Center for Data Analysis did with the president's tax-cut plan, using a model that enjoys wide use among Fortune 500 companies, prominent federal agencies and economic forecasting departments. The analysis shows that tax-cut naysayers are way off base.
Let's look first at the specifics of the president's plan. The five current tax brackets would be collapsed into four and lowered. The child tax credit would double to $1,000 per child. The "marriage penalty" would be reduced substantially. Non-itemizing taxpayers would be able to deduct charitable giving. And Bush would phase out the death (or estate) tax over 10 years and spur business development by making the business "research and experimentation" tax credit permanent.
All together, these cuts would return nearly $1.8 trillion to taxpayers over the next 10 years. But they would also generate $846 billion in new revenues through greater economic activity over the same period. Thus, the true net "cost" of the package is only $939 billion-less than one-fifth of the projected $5.6 trillion surplus that will be amassed over the next decade.
There's more good news. The Congressional Budget Office says unemployment will average 4.9 percent from 2002 through 2011. But our analysis suggests that the tax cuts will help businesses create 1.6 million more jobs-enough to lower the unemployment rate to 4.6 percent. We also found that a family of four would receive $4,680 in extra disposable income per year under Bush's plan, allowing the typical family to boost its consumer spending by $3,513 and its savings by $1,024 per year.
President Bush's plan is also good for Social Security. His proposed tax cuts not only would save the program's entire surplus but also add $87 billion to it, because higher employment would bring in more payroll tax revenue. Plus, the plan would leave the Medicare surplus untouched.
Meanwhile, the government still would accumulate $2 trillion in future surpluses, an amount that can be used for Social Security reform or for lower payroll taxes. And under the Bush plan, the federal debt would come as close to being retired as possible, given the fact that some $1 trillion of it is tied up in long-term treasury bills that can't be redeemed anytime soon. Under Bush's plan, the debt would fall to $818 billion by 2011-quite a drop from today's $3.4 trillion.
A "dynamic" analysis also shows that growing demand for goods and housing will cause prices and mortgage rates to rise slightly, as often happens in a strong economy. But higher family incomes and savings would offset these increases. Investment would increase $47 billion per year. And more vigorous economic activity would enhance Social Security's finances and leave the government in continued surplus.
In light of this, a better question would be: How much will it cost if Congress doesn't cut taxes as dramatically as President Bush would?
William Beach is director of the Center for Data Analysis at The Heritage Foundation. Mark Wilson is a former research fellow in Heritage's Roe Institute for Economic Policy Studies.
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