The tax and budget plans by Vice President Al Gore
and Texas Governor George W. Bush represent two different
approaches to governing. The Gore plan proposes to increase the
size and scope of federal spending while providing relatively small
and targeted tax cuts. The Bush plan proposes a smaller and more
limited increase in government spending while providing much larger
and broader tax relief.
More
specifically, the Vice President would use the tax code to
encourage certain activities. For example, taxpayers who care for
an elderly parent, use energy in a particular way, or whose
children go on to college would receive a tax cut, while many other
taxpayers would not.
The
tax measures in Governor Bush's plan generally do not require
taxpayers to engage in certain activities in order to receive tax
relief.
Under Bush's plan, all taxpayers receive a tax cut because all
marginal tax rates are reduced. Moreover, under the Governor's plan
taxpayers would keep more of their earnings to spend, save, and
invest as they see fit.
How
would these two plans, based on different approaches, affect the
economy and family budgets?
To
answer this query, the Heritage Foundation Center for Data Analysis
(CDA), at the request of Investor's
Business Daily, conducted a dynamic
simulation of both plans to assess their economic and budgetary
impacts. The results show that both plans increase economic growth
and family income while reducing federal debt, but they do so to
different degrees. For example: Governor Bush's plan would increase
a family of four's inflation-adjusted disposable income by $4,680
in fiscal year (FY) 2010, while under Vice President Gore's plan
the increase is just $2,536. Both plans would also save the entire
Social Security surplus while increasing personal saving.
To
conduct the simulation, CDA economists used WEFA's U.S.
Macroeconomic Model. CDA economists reconstructed
the July 2000 long-term model to embody the economic and budgetary
assumptions published by the Congressional Budget Office (CBO) in
July 2000. This specifically adapted model uses CBO budget
assumptions to produce dynamic simulations of policy changes. WEFA
and the Institute for Policy Innovation (IPI) have also conducted
simulations of the two plans (see Appendix
A for the key differences between the studies).
Some
analysts using static revenue and spending estimates have
calculated the budgetary impact of both plans. The Committee for a
Responsible Federal Budget (CRFB) estimates the Gore plan would
increase federal spending by $1,356 billion over ten years and
reduce tax revenue by $221 billion. The CRFB estimates the Bush
plan would increase federal spending by $482 billion and reduce tax
revenue by $1,321 billion. The CDA's dynamic analysis,
however, suggests that under the Bush plan, federal spending would
increase by $747 billion while revenue would decrease by just $756
billion. Under the Gore plan, the CDA's dynamic analysis projects
that federal spending would increase by $1,590 billion while tax
revenue would increase by $334 billion. The difference between the
static and dynamic estimates results from the increased economic
activity, higher employment growth, higher inflation, and higher
interest rates that both plans produce.
Specifically, the CDA's dynamic analysis
projects:
-
The Bush plan would increase economic
growth slightly more than the Gore plan.
Both plans would increase the rate of economic growth by an
average of 0.2 percentage points per year (from 2.7 percent to 2.9
percent) from FY 2001 to FY 2010 (see ). However, by the end of FY 2010, real gross domestic
product (GDP) would be $198.0 billion higher than the CBO baseline
forecast under the Bush plan, compared with $155.2 billion more
under the Gore plan (see Appendix B).
-
The Bush plan would increase family income
significantly more than the Gore plan.
By the end of FY 2010, the Bush plan would increase the
disposable personal income for a family of four (adjusted for
inflation) by $4,680, compared with just $2,536 under the Gore plan
(see Appendix B). In response to this
increase in family budgets, consumer spending would rise by $245.6
billion, or $3,297 per family of four, under the Bush plan,
compared with $132.5 billion, or $1,778 per family of four, under
the Gore plan.
-
The Bush plan would increase family
savings more than the Gore plan.
By the end of FY 2010, a family of four would be able to save
$1,222 more (adjusted for inflation) than the CBO baseline forecast
under the Bush plan, compared with $908 more under the Gore
plan.
-
The Bush plan would create more job
opportunities than the Gore plan.
Under the Bush plan, 1.5 million more Americans would be
working at the end of FY 2010, compared with an increase of 1.1
million under the Gore plan.
-
The Gore plan would increase investment
slightly more than the Bush plan.
The Gore plan would increase investment (adjusted for
inflation) by an average of $28.6 billion per year from FY 2001 to
FY 2010, compared with $27.6 billion per year under the Bush plan.
By the end of FY 2010, however, investment would be $61.7 billion
higher than the CBO baseline under the Bush plan, compared with
$53.2 billion under the Gore plan.
-
The Bush plan would increase inflation
slightly more than the Gore plan.
Under the Bush plan, inflation would average 2.9 percent per
year between FY 2001 and FY 2010, compared with 2.8 percent per
year under the Gore plan.
- Both the Bush and Gore plans would
increase home mortgage rates by the same amount.
Under both the Bush and Gore plans, 30-year mortgage rates
increase by an average of 0.6 percentage point per year (from 7.2
percent to 7.8 percent) between FY 2001 and FY 2010. Because of
lower unemployment and the Federal Reserve's assumed reaction to
higher levels of economic activity, both plans also would increase
short-term interest rates--Bush slightly more than Gore (0.8 and
0.7 percentage points, respectively).
The
CDA's dynamic analysis also reveals that the plans would have
different effects on the federal budget. Specifically, the results
suggest:
-
The Gore plan would increase federal
spending significantly more than the Bush plan.
The Gore plan increases federal spending by $1,590 billion
from FY 2001 to FY 2010, compared with $747 billion under the Bush
plan (see ).
-
The Gore plan would increase federal tax
revenue; the Bush plan would reduce it.
The Gore plan would increase federal tax revenue by $334
billion from FY 2001 to FY 2010, compared with a reduction of $756
billion under the Bush plan.
-
Both the Bush and Gore plans would
decrease the federal surplus.
The Bush plan would reduce the federal surplus by $1,503
billion from FY 2001 to FY 2010, compared with $1,256 billion under
the Gore plan. Neither plan dips into the Social Security surplus
from FY 2001 to 2010. In fact, because of higher employment and
payroll taxes, the Social Security surplus would increase by $83.8
billion under the Bush plan and $73.5 billion under the Gore
plan.
- The Gore plan would decrease federal debt
by more than the Bush plan.
The Gore plan would decrease federal debt to $166 billion in FY
2010, compared with $381 billion under the Bush plan. From FY 2001
to 2010, federal debt as a percentage of GDP would decline from
31.9 percent to 1.1 percent under the Gore plan, compared with a
decline from 32.0 percent to 2.4 percent under the Bush plan (see
Appendix B).
Part
of the different dynamic effects of the two plans comes from the
fact that Governor Bush's tax relief does not begin until 2002,
whereas some of Vice President Gore's tax reductions begin in 2001.
The tenth year of Governor Bush's tax relief does not occur until
2011--outside the current CBO forecast period. The Gore plan also
increases spending significantly more in 2001 and 2002 than the
Bush plan.
CONCLUSION
Governor Bush's and Vice President Gore's
tax and budget plans appear to have roughly similar effects on
overall economic growth, inflation, and interest rates. But the
substantial philosophical difference between the two plans--higher
spending vs. lower taxes--reveals itself most in such areas as the
disposable income of families and savings. Both plans reduce the
total federal surplus, but neither one dips into the Social
Security surplus. Both plans also reduce the federal debt to less
than three percent of GDP.
D.
Mark Wilson is a Research Fellow in the Thomas A. Roe
Institute for Economic Policy Studies, and William W. Beach is
the Director of the Center for Data Analysis, at The Heritage
Foundation.
Economists with the Center for Data
Analysis (CDA) followed a two-step procedure in analyzing the
budgetary and economic effects of Vice President Gore's and
Governor Bush's tax and budget plans.
First, static tax revenue and spending
estimates were obtained from the Congressional Budget Office (CBO),
the Committee for a Responsible Federal Budget (CRFB), Citizens for
Tax Justice (CTJ), and the Gore and Bush campaigns. These outside
sources were chosen in order to be as fair as possible to both
campaigns. The CBO, CRFB, CTJ, and Gore and Bush tax revenue and
spending estimates are based on a static methodology that does not
account for the macroeconomic effects that would result from a
reduction in tax rates or higher spending. These effects include
changes in the gross domestic product (GDP), interest rates,
employment, personal income, and inflation that can significantly
affect tax revenues and spending levels. As such, the static
estimates provide a limited analysis of the economic and budgetary
impact of any policy change. To forecast the change in federal tax
revenue, spending, and the economy more accurately, a dynamic model
must be used.
The
second step was to introduce the static revenue changes into the
WEFA U.S. Macroeconomic Model. The WEFA model is a dynamic model of
the U.S. economy that is designed to estimate how the general
economy is reshaped by policy reforms, such as tax law and spending
changes. CDA economists have developed a revised WEFA model for The
Heritage Foundation that embodies the economic and budgetary
assumptions published by the CBO in July 2000. This specifically
adapted WEFA model produces dynamic responses from the CBO baseline
as a result of proposed policy changes. In order to conduct
balanced simulations for both plans, only tax and spending changes
were made to the model. No adjustments were made to labor force
participation rates or relative prices.
DIFFERENCES
BETWEEN THE CDA, WEFA, AND IPI SIMULATIONS
WEFA
and the Institute for Policy Innovation (IPI) have each conducted
simulations of the Bush and Gore plans. While their analyses
produced similar results, there are four important differences
between the CDA, WEFA, and IPI simulations.
-
The baseline models are different.
While both WEFA and the CDA use the same model of the U.S.
economy, the CBO baseline versions of the model are slightly
different. The CDA CBO baseline is more detailed and more
accurately matches the CBO forecast published in July 2000. Because the
IPI uses their own model of the U.S. economy that is considerably
different from the WEFA model, their results are not directly
comparable to those of either WEFA or the CDA.
-
Different tax and spending estimates were
used.
All of the WEFA and IPI tax and spending estimates were
obtained from the Gore and Bush campaigns; some of these were based
on CTJ, CBO, and Office of Management and Budget (OMB) estimates.
The CDA used the tax and spending estimates of the plans scored by
the bipartisan CRFB. These estimates do not count items such as
savings from competition in Medicare or from the Quadrennial
Defense Review, or from closing corporate loopholes. Both WEFA and
the IPI count some targeted tax credits in the Bush plan as tax
cuts, while both the Bush campaign and CRFB count them as spending
increases.
-
Gore's Retirement Savings Program was
modeled differently.
The CDA modeled the Vice President's Retirement Savings
Program, the largest component of the Gore plan, as the CBO and OMB
would score it--as both a savings program and a tax cut. WEFA
modeled the entire program as a tax cut.
- Gore's EITC and Dependent Care Tax Credits
were modeled differently.
The CDA modeled the Vice President's EITC and Child and
Dependent Care Tax Credits as the CBO and OMB would score them--as
both a spending increase and a tax cut--while WEFA modeled the both
tax credits as tax cuts.
We
believe these four differences mean the CDA analysis more
accurately models both plans than does the WEFA analysis. The
effect of the CDA approach is to slightly reduce economic growth,
the number of jobs, personal income, and investment while
increasing savings under the Gore plan. This CDA analysis is,
however, limited. No adjustments were made to labor force
participation rates or to relative prices, even though economic
research suggests that reducing marginal tax rates, as the Bush
plan does, would increase the labor force and the number of hours
worked. If these adjustments were made, the difference between the
two plans significantly increases and the CDA results would more
closely match the IPI results.
The
following sections describe how the CDA static estimates were
introduced into the WEFA model to estimate the dynamic economic and
budget results.
STATIC TAX
REVENUE ESTIMATES
Static tax revenue estimates were obtained
from the CBO, CRFB, and CTJ. Revenue estimates for the Bush plan
were obtained from a CTJ publication using Joint Committee on
Taxation estimates. This report uses only the estimates for FY 2002
through FY 2010 since that is the current CBO forecast period. Most
of the estimates for the Gore plan were obtained from the
Gore-Lieberman economic plan published in September 2000. CRFB
estimates of the Gore plan's retirement savings program, Earned
Income Tax Credit, and Child and Dependent Care Tax Credit were
used to adjust for the spending components of those refundable
programs. The static revenue estimates were phased in according to
details provided by the CBO and JCT or, if no details were
available, the phase-in rates were assumed to be the same as the
CTJ published estimates for the Bush plan.
STATIC SPENDING
ESTIMATES
Static spending estimates for both plans
were obtained from the CRFB. The CRFB's spending estimates do not
count unspecified savings such as from competition in Medicare or
closing corporate loopholes. The CRFB spending estimates
for the Gore plan's retirement savings program, Earned Income Tax
Credit, and Child and Dependent Care Tax Credit were phased in
according to details provided in the Gore-Lieberman economic plan.
The cost of Governor Bush's recently announced energy policies was
added to the CRFB static estimate. The static spending estimates
were phased in according to details provided by the CBO or, if no
details were provided, the phase-in rates were assumed to be the
same for both plans.
DYNAMIC ECONOMIC
AND BUDGETARY ESTIMATES
The
WEFA model contains a number of variables that are used to simulate
proposed policy changes. The following changes were made in the
model.
Average Personal
Effective Tax Rate
The
WEFA model contains a variable that measures the total amount of
all federal taxes on individual income as a percentage of the
nominal personal income tax base. CDA economists adjusted this
average effective tax rate downward for each of the forecast years
to reflect the static revenue decrease estimates of both plans.
Corporate Tax
Revenue
The
WEFA model contains a variable that measures the total amount of
federal corporate tax revenue. Heritage economists adjusted the
revenue downward for each of the forecast years to reflect their
static revenue decrease estimates of both plans.
Indirect
Business Tax Revenue
The
WEFA model contains a variable that measures the total amount of
federal indirect business tax revenue. CDA economists increased the
revenue in the Bush plan simulation for FY 2002 and FY 2003 to
reflect the static revenue increase from the bid bonuses from
exploring the Arctic National Wildlife Refuge. No change was made
for the Gore simulation.
Federal Medicare
Spending
The
WEFA model contains a variable that measures the total amount of
federal Medicare spending. Heritage economists increased the
spending for each of the forecast years to reflect the static
revenue estimates of both plans.
Federal Health
Care Spending
The
WEFA model contains a variable that measures the total amount of
federal non-Medicare health care spending. Heritage economists
increased the spending for each of the forecast years to reflect
the static revenue estimates of both plans.
Federal Transfer
Payments
The
WEFA model contains a variable that measures the total amount of
other federal transfer payments to persons. Heritage economists
increased the spending for each of the forecast years to reflect
the static revenue estimates of both plans.
Federal Defense
and Non-Defense Spending
The
WEFA model contains variables that measure the total amount of
federal defense and non-defense spending. Heritage economists
increased the spending for each of the forecast years to reflect
the static revenue estimates of both plans.
Federal
Debt
The
specifically adapted baseline model used for the simulations
contains the CBO assumption that redeemable publicly held federal
debt will not fall below $800 billion in FY 2010. This results in a
significant accumulation of excess cash in the CBO baseline model.
This assumption was suspended for both plans, and debt was allowed
to fall to zero.
Monetary
Policy
The
model assumes that the Federal Reserve Board will react to this
policy change as it has historically. This assumption was embodied
in the Heritage model simulation by including the stochastic
equation in the WEFA model for monetary reserves for both
plans.
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