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
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
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
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.
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
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
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.
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
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
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
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.
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
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
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
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
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
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
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
Budget Office, An Analysis of the President's Budgetary
Proposals for Fiscal Year 2004, March 2003, at .
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.
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.
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
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
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),
For more information on hurdle rates,
see Norbert J. Michel, "Everyone Profits from Hurdling Dividends,"
Heritage Foundation Web Memo No. 248, April 3, 2003, at www.heritage.org.
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 .
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 .
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
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
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'
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
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
Congressional Budget Office, "The Budget
and Economic Outlook: An Update," August 2002, at (March 15,
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
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 .
R. Glenn Hubbard, "Testimony of R. Glenn
Hubbard, Chairman, Council of Economic Advisers, Before the Budget
Committee, United States Senate," February 4, 2003, at .
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
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
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
(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 .
See Congressional Budget Office, "Labor
Supply and Taxes," January 1996, p. 11, at (March 15,
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 (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 (March 24,
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.