April 16, 2003 | Center for Data Analysis Report on Federal Budget
This Appendix provides an overview of theoretical issues relevant to macroeconomic modeling of the Economic Growth Package. In addition, it includes specific modeling techniques used to apply these theoretical perspectives to the DRI- WEFA U.S. Macroeconomic Model.
Heritage Foundation economists in the Center for Data Analysis (CDA) used the DRI-WEFA model to analyze the fiscal and economic effects of the Economic Growth Package. The September 2002 forecast from the DRI-WEFA U.S. Macroeconomic Model was modified to make it consistent with the long-term budget and economic projections published by the Congressional Budget Office in August 2002. CDA analysts used this forecast as the baseline by which to analyze the effects of the President's proposal. Since both the DRI-WEFA model and the CBO projections terminated in 2012, CDA analysts extended its forecasts to FY 2013 using a linear trend of the dividend component forecast.
CDA economists first simulated the dividend exclusion component as if it were a separate proposal. Then changes associated with other components of the plan were "stacked" upon those changes made for the dividend component. This method allowed the researchers to identify the effects of the dividend plan separately from those of the remaining components. In each case, the effects of the static decline in federal revenue were introduced into the DRI-WEFA model.
CDA researchers applied information from three sources to calculate the year-by-year static revenue reductions resulting from the President's proposals. The first was the U.S. Department of the Treasury's year-by-year cost estimates of the plan spanning federal FY 2003 through FY 2008, broken down by plan component. The second was the Treasury Department's cumulative 11-year cost estimate of the plan, spanning federal FY 2003 to FY 2013, broken down by plan component. CDA analysts independently estimated these components for FY 2009 through FY 2013.
DIVIDEND TAX PROPOSAL
User Cost of Capital
The key element of the President's plan is the proposal to end the double taxation of corporate dividends by excluding dividend income from the personal income tax base. This proposal would affect the rate of capital accumulation in the nation's economy by reducing the user cost of capital. Calculations by Kevin Hassett and the Council of Economic Advisers indicate that this reform would reduce the user cost of capital by 4 percent to 7 percent for investment in equipment and substantially more for investment in structures. In simulating the dividend component of the Economic Growth Package, CDA analysts used an estimate of 5.5 percent as the static assumption for the amount that the dividend tax reform reduces the user cost of capital.
The DRI-WEFA model does not contain a variable that directly reflects the user cost of capital. However, changes in the user cost of capital can be represented by changes in federal rates of taxation on corporate income. Consequently, CDA analysts adjusted one of the federal corporate tax rate variables in order to reflect the reduction in the user cost of capital. However, this adjustment did not change the average federal tax rate on corporate income. The federal average tax rate on corporate income was not altered because the President's proposal does not call for any change in the statutory corporate tax rate.
Reduction in Personal Income Tax Collections
The President's plan to end the double taxation of dividends excludes corporate dividend income from the federal personal income tax base. Since the DRI-WEFA model does not provide a direct method for excluding dividends from the personal income tax base, CDA analysts simulated the effect of the proposal by reducing the average federal tax rate on personal income. This variable was reduced by an amount corresponding to the static reduction in personal income tax collections associated with the plan's dividend component.
Increased Dividend Payouts
The Treasury Department estimates that the President's dividend proposal would increase the dividend payout rate by 2 percentage points above the baseline in 2004 and 4 percentage points above baseline from 2005 through 2013. CDA researchers took account of this increase by adjusting upward a model variable corresponding to corporate dividends paid to persons.
To examine the effects of increasing the payout rate, CDA analysts performed a sensitivity analysis by conducting an alternative simulation in which the dividend payout rate was not adjusted upward. The alternative simulation projects that the 2004 through 2013 annual average increases in GDP, employment, and disposable income would be $64 billion, 808,000, and $109 billion, respectively. The results from this alternative simulation were not materially different from those reported in this study. (See Table 2.)
Lowering Marginal Propensity to Consume Out of Increased Disposable Income
Ending the double taxation of corporate dividends would provide relief to taxpayers directly owning shares in corporate enterprises. These taxpayers typically are persons with relatively higher saving rates and therefore relatively lower marginal propensities to consume. CDA analysts adjusted model variables controlling personal consumption expenditures in order to reduce consumption below the amount that would otherwise have been projected. The goal was to balance the relatively higher tendency to save against the tendency to increase spending due to a growth in net wealth.
The CDA reduced consumption by an amount equal to half of the dividend tax relief during the forecast period. In consultation with Global Insight, Inc., owners of the DRI-WEFA model, CDA analysts balanced the depressive effect of this consumption reduction on GDP by making offsetting adjustments to five component variables of personal income. The combined effect of these changes left personal income within an average of 95 percent of the unadjusted level of personal income.
Adjustment for Taxation of Additional Dividend Income
Since the DRI-WEFA model does not directly allow the exclusion of dividends from the federal personal income tax base, additional dividend income results in an increase in the tax base above the baseline. CDA analysts used a model variable that accounts for the difference in the definition of National Income and Product Accounts (NIPA) and the unified budget receipts to remove this additional dividend income from federal personal income tax collections, thus lowering total federal revenues under the simulation.
Non-Residential Fixed Investment
CDA analysts found that the
DRI-WEFA model's response of non-residential fixed investment
to the user cost of capital was lower than that supported by recent
literature. Consequently, when modeling
the dividend component of the President's plan, researchers
adjusted model variables controlling investment. In performing
this adjustment, CDA researchers were guided by an assumption that
the static elasticity of gross investment with respect to the
user cost of capital was
-1.2 percent for equipment and -0.64 percent for structures.
The reduction in the user cost of capital could be expected to exert a positive impact on the nation's economy by stimulating gross non-residential investment. Recent advances in the modeling of investment behavior show that reductions in the cost of capital brought about through tax policy lead to increased expenditures on business investment. Federal policymakers may find, however, that attempts to reduce the user cost of capital through tax reductions are partially offset by changes in federal fiscal balances.
CDA analysts adjusted model variables controlling investment to account for the possible effect of increased publicly held debt on gross investment. The CDA assumed that 60 cents of every dollar of increased net publicly held debt would displace private gross investment. Therefore, the CDA's forecasted increases in non-residential fixed investment are lower than they would have been in the absence of crowding out.
CDA researchers initially found that the forecasted ratio of additional GDP to additional employment was high by historical standards. Based on consultations with Global Insight, Inc., CDA analysts adjusted a model variable controlling wages to adjust this ratio. Left unadjusted, the higher ratio of GDP to employment would have increased federal revenues in the simulation.
CDA analysts initially found that the forecasted ratio of imports to GDP was high by historical standards. Analysts also initially found that the forecasted ratio of imported capital equipment to increased non-residential investment was higher than would be supported by historical averages. Therefore, based on consultations with Global Insight, Inc., CDA analysts adjusted model variables controlling the level of imports.
Federal Monetary Authority Response
CDA analysts assumed that the dividend exemption plan would not hinder the Federal Reserve's basic objective of maintaining economic growth without disturbing price stability. This assumption necessitated a slightly more accommodating monetary policy than is built into the adapted DRI-WEFA model. Researchers therefore reduced slightly a variable controlling the federal funds rate in the DRI-WEFA model. This change did not prevent the Federal Reserve from responding to the implementation of the plan in the simulation.
OTHER PROVISIONS IN THE ECONOMIC GROWTH PACKAGE
The remaining components of the President's plan consist of accelerations of the phase-ins for various provisions of the Economic Growth and Tax Reform Reconciliation Act of 2001 (EGTRRA), including reductions in marginal personal income tax rates, marriage penalty relief, widening of the 10 percent tax bracket, and increasing the child tax credit. In addition, the President's plan would increase the amount of the AMT exemption and provide for increased small business expensing. CDA analysts introduced these tax changes into the model by altering the variable controlling the average federal tax rate on personal income. These changes are in addition to those made to account for the dividend exclusion.
Labor Force Participation Rate
The acceleration of marginal tax rate cuts and the alternative minimum tax hold-harmless provisions would account for most of the reduction in marginal federal tax rates compared to the baseline. The four remaining components are the acceleration of the expansion of the 10 percent bracket, the acceleration of the increase in the child tax credit, the acceleration of marriage penalty relief, and raising the limits on expensing for small businesses. These four tax law changes would alter average federal personal income taxes somewhat but not significantly change marginal rates for most taxpayers.
Economic theory suggests that reductions in marginal personal income tax rates would increase participation in the labor force. The marginal rate cuts would, in turn, benefit the economy by strengthening the incentives to work and save. Stronger economic incentives could be expected to increase the labor force participation of some groups. In fact, microeconomic theory indicates that lowering marginal tax rates on labor income generally increases labor force participation.
One important modeling consideration, therefore, is the responsiveness of labor participation to changes in after-tax income, commonly referred to as the participation labor supply elasticity. A meta-study performed by the Congressional Budget Office examined the range of estimates for this elasticity with respect to after-tax inflation-adjusted income. It found that estimates were as low as 0.1 percent and as high as 0.2 percent.
CDA researchers estimated the amount that the proposal would add to labor market participation by applying an appropriate elasticity to the static reduction of average federal personal income tax rates associated with the marginal tax rate cuts and a portion of the AMT provision. Analysts used an estimate in the middle of a range published by the CBO as an appropriate labor supply elasticity. Specifically, for each static 1 percent increase in after-tax labor income, the labor supply was assumed to rise by 0.15 percent. Researchers applied this 0.15 percent rate to the increase in after-tax labor income directly attributable to those provisions in the plan that would reduce marginal personal income tax rates.
Some economists have expressed concern regarding the impact that tax law changes could have on national saving. One concern is that tax reductions could reduce national saving by lowering the federal surplus component of national saving more than they would raise the private component of saving. The fear is that a reduction in national saving could lead to a fall in the capital stock owned by Americans and a fall in future national income. However, the CDA analysis of the Economic Growth Package found that implementing the plan would raise national saving compared to the baseline during each year of the forecast.
CDA Use of the August 2002 Baseline
In performing these simulations, CDA analysts used a baseline derived from the August 2002 economic and budget projections of the CBO. This section examines how the results of the study might have been different if the January 2003 CBO projections had been used to construct the baseline instead of the August 2002 projections.
Implications for Different Periods
In the near term (through FY 2004), this analysis would probably have found a stronger improvement in economic and employment growth if the later forecast had been used. This is because the August projections call for growth of 2.9 percent in real (inflation-adjusted) GDP, while the January 2003 forecast foresees 2.4 percent growth. Slower growth would have indicated an economy performing further below its potential during 2003 than in the August projections. In such an economic environment, the impact of the plan would likely bring about more growth without straining economic capacity than would be the case in the environment described in the August baseline. It is also likely that using the January baseline would have brought about smaller changes in interest rates.
For the year FY 2004, both sets of forecasts predict the same real GDP growth rate. However, in the January 2003 forecast, that GDP growth would be from a lower base because of the slower growth recorded the previous year, so the economic and employment growth effects that year would also likely have been higher if the January CBO forecast had been used to construct the baseline.
In their January projection, the CBO estimates that real GDP in federal FY 2005 will nearly catch up to the real GDP level projected in its August forecast. Real GDP growth for 2005 is projected at 3.5 percent in the January forecast and only 3.1 percent in the August forecast. Consequently, using the January forecast as a baseline rather than the August forecast could have resulted in a finding of slower economic growth in the year 2005. In the five full fiscal years following 2005, the growth rates for GDP follow very similar paths, so it is likely that the use of the August baseline did not materially affect study results for that period.
Real GDP growth, profit growth, and wage growth for 2011-2012 declined markedly in the January forecast compared to the August forecast. The January forecast calls for average real GDP growth of 2.5 percent during that period compared with 3.0 percent growth in the August forecast. Other economic indicators remain essentially unchanged for these years between the two sets of projections. These include the unemployment rate, the three-month Treasury bill rate, and the 10-year Treasury bond rate. Combined, these differences imply that using the January forecast to construct the baseline would likely have led to finding stronger improvement in economic growth under the President's plan for these years. This occurrence is more likely because the economy would be performing further below potential in the January forecast compared to the August forecast.
If the analysis had been performed on a baseline derived from the more recent January 2003 projections, the study would probably have found long-term average results similar to those presented in this paper. This is because of the long-term similarities in the two sets of projections. The similarities indicate the CBO's belief that elements of the economic environment affecting the long term have changed only slightly in the period intervening between the calculations of the two projections.
Over a common 11-year period, the forecasts are very similar in most respects. For example, the August 2002 economic projection shows GDP growing at an average rate of 2.81 percent during 2002-2012, while the later forecast has 2.88 percent. The GDP price index is seen growing at 1.97 percent for 2002-2012 in the earlier projection and at 1.98 percent in the later one. The consumer price index grows at an annual average rate of 2.46 percent in the August projection and 2.34 in the January projection. These similarities indicate that the simulation results would not have been substantially different if the later set of CBO projections had been used.
Unlike other economic indicators, there is a noticeable difference in interest rates between the two economic forecasts. The three-month Treasury bill average interest rate during 2002-2012 declines from 4.4 percent in the August 2002 projection to 4.1 percent in the later. The 10-year Treasury bill average interest rate for the same period also falls from 5.7 percent to 5.5 percent. The interest rate differences indicate that using the January baseline might have led to stronger economic growth than results based on the August baseline. Lower interest rates, for instance, would have indicated that the economy was performing further below its potential in the January projections compared to the August projections.
The broad measures of federal fiscal health are remarkably similar in the two sets of projections. Unified federal revenues in the August forecast total $28.2 trillion (not adjusted for inflation) during the years 2002-2012 and $28.0 trillion in the January forecast. This change reflects a 0.7 percent decline over the period. Similarly, spending rises from $27.4 trillion to $27.6 trillion between the two forecasts, a 0.7 percent change. Cumulative surpluses fall from $858 billion during the period to $470 billion in the later forecast. This reduction represents a 55 percent decline. However, this large decline is deceptive because it reflects very small underlying changes in both the spending and revenue outlooks.
CDA used the DRI-WEFA Mark 11 U.S. Macroeconomic Model, owned by Global Insight, to conduct this analysis. The model was developed by Nobel prize-winning economist Lawrence Klein and several colleagues at the University of Pennsylvania's Wharton School of Business. The methodologies, assumptions, conclusions, and opinions in this report are entirely the work of Heritage Foundation analysts. They have not been endorsed by, and do not necessarily reflect the views of, the owners of the model.
Unless otherwise noted, to maintain comparability with published CBO long-term projections, projections of changes in federal spending and revenue are not adjusted for inflation in this paper.
 Budget of the United States Government, Fiscal Year 2004: Analytical Perspectives (Washington, D.C.: U.S. Government Printing Office, 2003), pp. 81, 83.
The differences between static and dynamic analysis are discussed in greater detail in subsequent sections of this report.
CDA analysts modeled the President's Economic Growth Package as described in Budget of the United States Government, Fiscal Year 2004: Analytical Perspectives, pp. 66-68. As described in this document, the Economic Growth Package does not include a provision for personal reemployment accounts. The CBO analysis, however, does include a provision for personal reemployment accounts in the Economic Growth Package. See Congressional Budget Office, An Analysis of the President's Budgetary Proposals for Fiscal Year 2004, p. 46.
See Congressional Budget Office, An Analysis of the President's Budgetary Proposals for Fiscal Year 2004, p. 46.
The terms "cost of capital" and "return to capital" are closely related. For example, the return on capital that a firm has to provide to an investor is the cost of employing that capital. Lowering the tax on this capital thus results in added incentives to invest and, therefore, purchase the capital.
The term "double taxation" refers only to the federal taxation of dividends. When state and local taxes are considered, there are more than two layers of taxation on dividend income. However, the President's proposal eliminates only the personal federal layer of this taxation.
For academic studies on the economic effects of federal double taxation of dividends, see James M. Poterba, "Tax Policy and Corporate Saving," Brookings Papers on Economic Activity No. 2, 1987, pp. 455-515; Peter Birch Sorensen, "Changing Views of the Corporate Income Tax," National Tax Journal, Vol. 48, Issue 2 (June 1995), pp. 279-294; James M. Poterba and Lawrence H. Summers, "The Economic Effects of Dividend Taxation," National Bureau of Economic Research Working Paper No. 1353, 1984; and James M. Poterba and Lawrence H. Summers, "New Evidence That Taxes Affect the Valuation of Dividends," The Journal of Finance, Vol. 39, Issue 5 (December 1984), pp. 1397-1415.
Deborah Thomas and Keith Sellers, "Eliminate the Double Tax on Dividends," Journal of Accountancy, November 1994; Ervin L. Black, Joseph Legoria, and Keith F. Sellers, "Capital Investment Effects of Dividend Imputation," The Journal of the American Taxation Association, Vol. 22, Issue 2 (2000), pp. 40-59.
For a discussion of the shortcomings of static analysis of the effects of tax policy changes, see Daniel J. Mitchell, "The Correct Way to Measure the Revenue Impact of Changes in Tax Rates," Heritage Foundation Backgrounder No. 1544, May 3, 2002, at www.heritage.org/Research/Taxes/BG1544.cfm. See also "The Argument for Reality-Based Scoring," Heritage Foundation Web Memo No. 92, March 29, 2002, at www.heritage.org/Research/Taxes/WM92.cfm, and Daniel R. Burton, "Reforming the Federal Tax Policy Process," Cato Institute Policy Analysis No. 463, December 17, 2002, at www.cato.org/pubs/pas/pa-463es.html.
This amount is slightly different from the CBO definition of the Economic Growth Package, which includes a provision for personal reemployment accounts. Based on this definition, the CBO states that the Treasury's static federal revenue reduction for the plan is $642 billion. See Table 11, footnote D, in An Analysis of the President's Budgetary Proposals for Fiscal Year 2004, p. 46, at www.cbo.gov.
See Figure 15.
For a discussion of the plan's fiscal effects on national saving, see the Appendix.
For example, both Democratic leaders in the U.S. Congress have proposed one-time tax rebates as important elements of their own economic growth plans. Democratic House leader Nancy Pelosi (D-CA) proposed a refundable tax rebate of $300 per adult in a family, up to $600 per family. See Office of the House Democratic Leader, "House Democratic Economic Stimulus Plan," January 6, 2003, at www.house.gov/budget_democrats/analyses/econ_stimulus/ house_dem_stimulus_plan.pdf (March 23, 2003). On February 14, 2003, Senator Thomas Daschle (D-SD) introduced a tax rebate of $300 per adult in a family and $300 for every child, up to $1,200 per family. See Library of Congress, "S‑414, Economic Recovery Act of 2003," February 14, 2003, at thomas.loc.gov.
National Bureau of Economic Research economists Matthew D. Shapiro and Joel Slemrod analyzed data on the University of Michigan Survey of Consumers to study the consumption effects of the tax rebate component of the 2001 EGTRRA tax cut. They found that only 22 percent of responding households were planning to spend the rebate. In addition, Shapiro and Slemrod found that the likelihood of spending varied only slightly across income levels and actually increased with income level. It was also slightly higher among households owning stock than among non-stockholding households. This finding is consistent with the holdings of modern economic consumption theory, which maintains that most people do not base their consumption decisions on their current level of income, but instead on their current estimate of their lifetime level of income. Thus, people receiving a windfall, such as a temporary personal income tax reduction, are likely to save a significant share of that windfall and increase consumption slowly afterward. Conversely, people suffering a temporary reduction in income or wealth, such as a temporary personal income tax increase, tend to reduce consumption slowly and decrease savings in order to maintain their previous level of consumption. See Robert P. O'Quinn, "The Effects of the Duration of Federal Tax Reductions: Examining the Empirical Evidence," Joint Economic Committee, February 2002, p. 2, at www.house.gov/jec/tax.htm. For more on the shortcomings of tax rebates as a form of economic stimulus, see Norbert Michel, "Fact v. Fiction: Tax Rebates," Heritage Foundation Web Memo No. 192, January 27, 2003, at www.heritage.org/Research/Taxes/wm192.cfm.
See William W. Beach, "A Side-by-Side Comparison of President Bush's and Senator Daschle's Plans to Boost Economic Growth," Heritage Foundation Web Memo No. 231, March 20, 2003, at www.heritage.org/research/taxes/wm231.cfm.
Calendar year results were used for comparison purposes only and are slightly different from the fiscal year results shown in Table 1.
This simulation was performed for the Business Roundtable by PricewaterhouseCoopers using the Inforum model at the University of Maryland.
As of this writing, CDA analysts do not have sufficient information to evaluate Decision Economics' forecast.
Ibid., p. 2.
Patrick Newport, "Bush Plan Boosts Short-term U.S. Growth, But Adds to Deficits," Global Insight, February 28, 2003.
Macroeconomic Advisers, A Preliminary Analysis of the President's Jobs and Growth Proposals, Special Analysis, January 10, 2003, p. 2.
Unless otherwise noted, years in this section are federal fiscal years.
MA also reported a decline in potential GDP for 2017, a measure that could be mistaken for actual GDP. Potential GDP, however, is different from actual GDP in that it is a theoretical measure of the level of real output that an economy could produce.
Macroeconomic Advisers, A Preliminary Analysis, chart on p. 7.
This assumption required CDA analysts to adjust downward, compared to the baseline, a model variable controlling the Federal Funds Rate (see the Appendix for details); a downward adjustment corresponds to a more accommodating monetary policy than is built into the model.
For a simulation of the Democrat plan, however, GI modeled an accommodating Federal Reserve that held interest rates to baseline. See Newport, "Bush Plan Boosts Short-term U.S. Growth," p. 3.
Macroeconomic Advisers, A Preliminary Analysis, p. 6.
Business Roundtable, "BRT Study on Economic Jobs and Growth Plan."
Newport, "Bush Plan Boosts Short-term U.S. Growth." To examine the effects of increasing the payout rate, CDA analysts performed a sensitivity analysis in which the dividend payout rate was held to baseline. The results from this alternative simulation were not materially different from those reported in the paper. For details, see the Appendix.
The Center for Data Analysis at The Heritage Foundation used the DRI-WEFA Mark 11 U.S. Macroeconomic Model, owned by Global Insight, to conduct this analysis. The model was developed by Nobel Prize-winning economist Lawrence Klein and several colleagues at the University of Pennsylvania's Wharton School of Business. The methodologies, assumptions, conclusions, and opinions in this report are entirely the work of Heritage Foundation analysts. They have not been endorsed by, and do not necessarily reflect the views of, the owners of the model.
The same rate of growth used to extrapolate the dividend forecast was used to extrapolate the final year of the overall plan because the majority of the other provisions would have expired by 2013.
Budget of the United States Government, Fiscal Year 2004: Analytical Perspectives, pp. 81, 83.
The resulting estimates are similar to those used in Macroeconomic Advisers' year-by-year estimate of the static revenue effects of the plan. See Macroeconomic Advisers, A Preliminary Analysis.
Kevin A. Hassett, "Evaluation of Proposals for Economic Growth and Job Creation: Incentives for Investment," testimony before the Senate Finance Committee, February 12, 2003, at www.aei.org/news/newsID.15964/news_detail.asp.
R. Glenn Hubbard, "Testimony of R. Glenn Hubbard, Chairman, Council of Economic Advisers, Before the Budget Committee, United States Senate," February 4, 2003, at www.senate.gov/%7Ebudget/democratic/testimony/2003/hubbard_hrng020403.pdf.
The observed (dynamic) change in the user cost of capital was not quite 5.5 percent because the reduction in federal revenue and the increased economic activity associated with ending double taxation of corporate dividends would exert upward pressure on the user cost of capital. The CDA simulation of the dividend component alone found that the user cost of capital averaged 5.3 percent lower under the plan than under current law during 2004-2013. The CDA simulation of the Economic Growth Package found that the user cost of capital averaged 4.0 percent lower during 2004-2013.
Business Round Table, "BRT Study on Economic Jobs and Growth Plan."
Many economists believe that equity values would rise as a result of ending the double taxation of dividend income and that this rise in stock market values would increase the amount of consumption because of wealth effects.
CDA analysts performed tests of the DRI-WEFA model and found that even when accounting for crowding out, the response within the model of non-residential fixed investment to changes in the user cost of capital was weaker than is supported by recent literature. For literature citation, see footnote 47.
These elasticities are consistent with those found in 1992 by Jason Cummins and Kevin Hassett. Cummins and Hassett's findings indicate that the effective elasticities were lower because a portion of the increase in investment caused by the reduction in the user cost of capital was assumed to be crowded out by increases in net publicly held debt. On elasticities, see Jason Cummins and Kevin Hassett, "The Effects of Taxation on Investment: New Evidence from Firm Level Panel Data," National Tax Journal, Vol. 45, No. 3 (September 1992), pp. 243-251, at ntj.tax.org/wwtax/ntjrec.nsf/4F54FD9041AEC3118525686C00686DFA/$FILE/v45n3243.pdf (March 17, 2003). On crowding out, see footnote 47.
In other words, the elasticity of non-residential fixed investment with respect to the user cost of capital was applied to investment net of crowding out. The rule of thumb that every dollar increase in net publicly held debt displaces 60 cents of private investment is reported in the 2003 Economic Report of the President. This rule of thumb is distinct from the crowding out effect on interest rates. Even using this rule of thumb, the effect of crowding out on interest rates can be negligible. See Economic Report of the President (Washington, D.C.: U.S. Government Printing Office, 2003), p. 56.
The simulation found that the dividend plan alone would increase the net physical capital stock by 2.0 percent in FY 2013. From FY 2004 through FY 2013, the user cost of capital would fall by an average of 5.3 percent and GDP would rise by an average of 0.44 percent. This relationship among changes in the capital stock, the use cost of capital, and GDP is consistent with recent empirical analysis. See Robert S. Chirinko, Steven M. Fazzari, and Andrew P. Meyer, "That Elusive Elasticity: A Long-Panel Approach to Estimating the Price Sensitivity of Business Capital," Emery University Department of Economics Working Paper 02-02, January 2002, at userwww.service.emery.edu/%7Ecozden/chirinko_02_02_cover.html.
See William G. Gale and Peter R. Orszag, "The Economic Effects of Long-Term Fiscal Discipline," Urban-Brookings Tax Policy Center, Discussion Paper, December 17, 2002, at www.brook.edu/views/papers/gale/20021217.htm (March 24, 2003); William G. Gale and Samara R. Potter, "An Economic Evaluation of the Economic Growth and Tax Relief Reconciliation Act of 2001," Brookings Institution, March 2002, at www.brook.edu/views/articles/gale/200203.htm (March 24, 2002); and Alan J. Auerbach, "The Bush Tax Cut and National Saving," National Bureau of Economic Research Working Paper No. 9012, December 2002, at emlab.berkeley.edu/users/auerbach/bushtaxcut.pdf (March 24, 2003).
The CDA analysis includes changes in the state and local government component of national saving. In contrast, Gale and Potter note that "We ignore any induced effects [of the tax cut] on savings by state and local government." Auerbach states that a simplifying assumption used in his analysis was "the omission of the state and local fiscal sector." See Gale and Potter, "An Economic Evaluation of the Economic Growth and Tax Relief Reconciliation Act of 2001," and Auerbach, "The Bush Tax Cut and National Saving."
Comparisons of the August 2002 and January 2003 baselines are based on a geometric mean average of the annual growth rates.