Congressional efforts to fashion the fiscal year (FY) 2004
federal budget come at a time when the United States faces weaker
than expected job growth, shrinking consumer confidence, and a
heightened level of risk and uncertainty. Given these
circumstances, policymakers should carefully consider
opportunities to improve the U.S. economy.
Among the plans being considered is one that President George W.
Bush proposed on January 7, 2003a bold tax reform proposal that
would increase economic growth. The components of the Presidents
Economic Growth Package include ending double taxation of
corporate dividends, accelerating the tax rate reductions enacted
in 2001, and accelerating other provisions of the 2001 law,
such as marriage penalty relief.
This report from the Center for Data Analysis (CDA) at The
Heritage Foundation explores the implications for the U.S. economy
and federal revenues of implementing the Presidents Economic
Growth Package. Therefore, this report should be viewed as
complementary to the recent analysis of President Bushs FY 2004
budget issued by the Congressional Budget Office (CBO). Rather than analyzing the entire
set of budget proposals at once, as done by the CBO, this CDA
Report analyzes only the Economic Growth Package, a
specific tax cut provision in the Presidents budget.
Assuming that the plan becomes effective on July 1, 2003, CDA
analysts simulated its effects using the DRIWEFA U.S. Macroeconomic
Model and the CDAs Individual Income
Tax Model. CDA economists found that implementing the
Presidents proposal would improve the nations economic growth and
employment level throughout the next 10 years while increasing the
nations capital stock.
Unlike short-term and temporary stimulus plans, such as S. 414,
introduced by Senator Thomas Daschle (DSD), the Presidents plan
creates the conditions needed for both near- and long-term growth.
Compared to the baseline forecast, CDA analysts project:
Higher gross domestic product
Gross domestic product (GDP) would increase by an average of
$69 billion in inflation-adjusted dollars from FY 2004 through FY
2013, with roughly 73 percent of this increase derived from the
plans dividend exclusion component. (See Figure 1.) Furthermore,
the Economic Growth Package would increase GDP by $84 billion in
2004 and $81 billion in 2005, suggesting that the Presidents plan
would boost the economy in the near term.
More job opportunities
The employment level would average 844,000 additional jobs from FY
2004 through FY 2013, with projected increases of 997,000 in
2004 and 1,036,000 in 2005. Approximately 68 percent of the plans
average job growth from FY 2004 through FY 2013 would result from
ending the double taxation of dividends. (See Figure 2.) The
overall increase in jobs would correspond to an average decline in
the unemployment rate of no less than 0.5 percent over these 10
Added disposable personal income
Disposable personal income (after adjusting for
inflation) would be almost $179billion higher in FY 2004 and
would increase by an average of $121 billion from FY 2004 through
FY 2013. Over the same 10-year period, disposable income for a
family of four is projected to increase an average of $1,653. The
dividend exclusion component of the plan would account for 64
percent of the plans overall average increase in disposable
personal income from FY 2004 through FY 2013. (See Figure 3.)
Higher economic growth lowering the Treasurys
static revenue effect by 57 percent
Static estimates suggest the Economic Growth Package
would reduce federal revenue by about $638 billion from FY 2004
through FY 2013. However, the CDAs dynamic
estimates show that the proposal would reduce federal revenue
during the period by only $274 billion. (See Figure 4.) Moreover,
the CDAs dynamic analysis estimates that the dividend
component would bring about a total revenue reduction of $143
billion, far less than the static estimate of $360 billion. Unlike
the conventional static method, the dynamic method employed by the
CDA accounts for the effects of the plans greater economic
activity. Figure 4, which compares the
static and dynamic projections for federal revenue, shows that the
estimation method chosen can make a large difference in the
projected revenue reduction.
The structure of this CDA Report is as follows. The first
section discusses the provisions of the Economic Growth Package.
The next section explains the economic results for the dividend
component of the plan and is followed by a similar analysis of the
entire plan. The subsequent section compares the Economic Growth
Package to other types of tax proposals, and the final section
summarizes CDA results compared to those of other
The Appendix contains a review of the economic analysis and
the methods used to produce the economic simulations. In addition,
the Appendix contains charts showing the historical trends for
key economic indicators and a table listing the year-by-year data
from the analysis of the Economic Growth Package.
provisions of the Presidents Economic
The provisions of the Economic Growth Package can be
divided into the following categories: excluding corporate
dividends from individual taxable income; accelerating several
provisions of the Economic Growth and Tax Relief
Reconciliation Act of 2001 (EGTRRA); increasing small
business expensing; and increasing the exemption for the
alternative minimum tax (AMT).
Excluding Corporate Dividends from
Individual Taxable Income
Under the Economic Growth Package, dividends paid to
individuals would be excludable from taxable income provided they
were paid out of after-tax corporate income. Each year,
corporations would report the amount of excludable
dividends to their shareholders. Additionally, corporations
would report the amount of excludable retained earnings to
their shareholders. This amount could be used by individuals to
adjust their basis when selling shares of stock, an adjustment
that would reduce their capital gains tax liability.
Dividends not taxed at the corporate level would not qualify as
excludable. For example, if a corporation distributed $100 in
dividends but paid no federal income taxes on those funds,
shareholders would not be able to exclude any of the $100 from
their personal income taxes. However, since firms would be
required to calculate the amount of excludable dividends,
individual shareholders would only have to report dividends as
directed by the firms.
Acceleration of EGTRRA Provisions
Four of the Economic Growth Packages components accelerate
the phase-in of provisions contained in the Economic Growth
and Tax Relief Reconciliation Act of 2001. These components are
marriage penalty relief, expanding the 10 percent tax bracket,
reducing marginal tax rates, and increasing the child tax credit.
These provisions are currently scheduled to phase in throughout the
next seven years.
Under the Presidents proposal, the standard deduction for
married couples would be increased to double the amount of the
standard deduction for single filers in 2003. Also in 2003, the
width of the 15 percent bracket for married couples would be
increased to twice the width for single filers. These marriage
penalty relief provisions would otherwise phase in over the period
2005 to 2009.
The 10 percent bracket would be fully expanded in 2003 rather
than 2008. In addition, the bracket would be indexed for inflation
beginning in 2008. The endpoint for the 10 percent bracket
would be increased from $12,000 of taxable income to $14,000
for married couples and from $6,000 to $7,000 for single
The reduction in income tax rates scheduled for 2004 and 2006
would take effect in 2003. Under current law, the rates above the
15 percent bracket are 27, 30, 35, and 38.6 percent. The new rates
would be 25, 28, 33, and 35 percent, respectively.
In addition, under current law, an increase in the child tax
credit is set to phase in between 2005 and 2010. Under the
proposal, the amount of the child tax credit would be increased
from $600 to $1,000 in 2003. Additionally, this increased credit
would be paid in advance (beginning in July 2003) based on the
information in the taxpayers 2002 tax return. These provisions
would combine to lower federal income taxes for a broad range of
Increased Small Business Expensing and
Two additional provisions are included in the Economic Growth
Package. The first is a provision that would increase the maximum
amount of investment in qualified new equipment that could be
immediately expensed by small businesses (Section 179 Expensing).
This amount would be increased from $25,000 to $75,000 beginning in
2003. The amount of investment eligible for this immediate
deduction would begin to phase out for investments above $325,000
(up from $200,000). The new dollar amounts would be indexed for
inflation beginning in 2004.
The amount of the alternative minimum tax exemption would also
be increased by $8,000 for married taxpayers and by $4,000 for
unmarried taxpayers in 2003 through 2005. Without this provision,
some taxpayers whose regular income tax would be reduced by other
provisions in the plan would see their AMT liability increase.
Economic and fiscal Effects of the
Economic Growth Package
Although it contains various types of changes in tax law, the
Presidents proposal is designed to create economic growth
primarily through the dividend exclusion and reductions in
individuals marginal tax rates. Economists hold a variety of views
on how changes in tax policy affect individual behavior and,
therefore, the economy. These views can be categorized into those
that focus on increasing aggregate demand and those that focus on
increasing aggregate supply.
Aggregate demand measures the total amount of goods and services
that households, firms, and governments are willing to buy at given
aggregate price levels. Aggregate supply measures the total amount
of goods and services that households, firms, and governments are
willing to produce at given aggregate price levels.
Policies aimed at increasing aggregate demand are designed to
move the economy closer to full employment, given the current level
of capacity. Policies aimed at bolstering aggregate supply increase
employment levels by raising the long-run productive capacity of
the economy. The tax reductions in the Economic Growth Package are
consistent with the view that strengthening supply-side
incentives is the best way to bolster the economy.
A recent report by the CBO classifies demand-side effects as
cyclical changes caused by the business cycle. These changes occur
during a business cycle and are associated with increases in
the unemployment rate during a recession and decreases during an
economic boom. Supply-side changes are seen as those that increase
the capacity of the economy.
For example, the Presidents proposal would allow individuals to
keep more of the next dollar they earn by lowering marginal income
tax rates. This benefit, in turn, would provide an added incentive
for individuals to work more, whether through longer hours or
joining the labor force. Similarly, lowering the tax on firms cost
of capital, achieved by ending the double taxation of
dividends, would strengthen incentives to invest. In addition, the proposal has an
important demand-side component, as it increases taxpayers
purchasing power through changes in the personal income tax
Stronger incentives would, in turn, lead to increased purchases
of business equipment, machinery, and structures. An increase in
the capacity of plant and equipment and its quality commonly is
associated with an expansion of the labor force, and this effect
can be seen in the results of the CDA analysis.
In practice, care must be taken to distinguish supply-side
policies from supply-side effects. For example in its
modeling, the CBO attributed the decrease in the unemployment rate
following enactment of the Presidents budget to demand-side
effects. Assuming that demand-side effects (classified as cyclical
effects) reduced the unemployment rate leads naturally to the
conclusion that they also caused much of the new economic growth
and the increased tax revenues.
Supply-side tax policies, however, are designed to create jobs
and economic growth now and in the future. Yet, as the CBO report
shows, much of the short-run effects of the supply-side
policies are sometimes classified as cyclical rather than
supply-side. The CBO method does not allow analysts or policymakers
an opportunity to compare the effects of different types of
policies. In contrast, by separating the dividend proposal from the
other components of the Economic Growth Package, the CDA analysis
can be used to study the effects of the different types of
Macroeconomic Effects of Ending Double
Taxation of Dividends
The importance of the supply-side approach can be observed by
comparing the projected effects of eliminating the double taxation
of dividends to the projected effects of the entire plan. In virtually all key economic
categories, CDAs projections show that eliminating the double
taxation of dividends is the most beneficial component of the
Economic Growth Package. Unless otherwise noted, all amounts
discussed below are adjusted for inflation, and all fiscal year
differences are compared to a baseline forecast.
Specifically, the analysis projects that eliminating the
double taxation of dividends would:
GDP would increase by an inflation-adjusted average of $51
billion from FY 2004 through FY 2013. This figure represents
roughly 73 percent of the Economic Growth Packages projected
additional GDP. (See Figure 1.)
Create more job opportunities
The dividend provision accounts for 577,000 (68 percent) of
the plans projected total job growth of 844,000. (See Figure 2.)
This increase in jobs would correspond to an average decline in the
unemployment rate of 0.4 percent per year over these 10 fiscal
Increase disposable personal income
Disposable personal income would increase by an
inflation-adjusted average of more than $77 billion from FY 2004
through FY 2013, representing 64 percent of the plans
projected average increase. For a family of four, the increase
in disposable income resulting from the dividend component
would average at least $1,054. (See Figure 3.)
Provide additional investment
The dividend component of the Presidents plan would
contribute an average of almost $53 billion in additional
non-residential investment between FY 2004 and FY 2013. (See Figure
5.) This average shows that the dividend element accounts for
approximately 90 percent of the plans projected investment
increase. By FY 2013, the plans dividend component would account
for about 95 percent ($327 billion) of the increase to the nations
Economists have long argued that the double taxation of
dividends reduces the after-tax return on capital in the nations
economy and thus discourages corporate investmentincluding
purchases of new business equipment and machinery. This reduced corporate
investment weakens economic growth. Recognizing that
eliminating the double taxation would produce greater
corporate investment and economic growth, several
nationsincluding Australia, France, Italy, Canada, Germany, Japan,
and the United Kingdomhave abolished or reduced their double
taxation of corporate dividends.
Under current law, corporations pay dividends to their
shareholders out of after-tax profits. This dividend income,
despite being taxed at the corporate level, is taxed again as
personal income on shareholders individual income tax returns. This
added layer of taxation can have several deleterious
The clearest economic effect of this tax is that it raises the
cost of capital, making it more expensive for firms to invest. By
eliminating this duplicate layer of taxation, the Presidents plan
would lower the cost of capital. Reducing the cost of capital (the
price of investment) allows corporate managers to invest more, even
in the face of increased risk.
For any given set of investment projects, a firms cost of
capital can be thought of as a hurdle rate. A capital project that
is not expected to return at least the cost of capital will not be
undertaken because it does not clear the hurdle. After lowering the
cost of capital, projects which previously failed to clear the
hurdle rate would then do so. As firms invest
in more capital projects, they hire additional workers and the
Macroeconomic Effects of the Entire
Economic Growth Package
Table 2 in the Appendix contains a year-by-year reporting of key
economic results from the CDAs dynamic analysis of the Economic
Growth Package. Unless otherwise noted, all amounts
discussed below are adjusted for inflation and represent
fiscal year differences compared to a baseline forecast. These
results suggest that implementing the plan would:
GDP would increase by an average of at least $69 billion from
FY 2004 through FY 2013. (See Figure 1.) GDP is projected to
be $84 billion higher in 2004 and $81 billion higher in 2005.
Create more job opportunities
The Presidents plan is projected to add an average of
approximately 844,000 jobs from FY 2004 through FY 2013. (See
Figure 2.) Furthermore, the plan is projected to increase
employment by 997,000 jobs in 2004 and 1,036,000 jobs in 2005. Over
this same 10-year period, the Economic Growth Packages increase in
jobs would correspond to an average decline of 0.5 percent in the
Increase disposable personal income
Disposable personal income is projected to increase by an
average of $121 billion from FY 2004 through FY 2013, with a
projected increase of $179 billion in 2004. For a family of four,
disposable income is projected to increase by an average of $1,653
over the 10 years. (See Figure 3.)
Add to investment
Non-residential investment is projected to increase an
average of $57 billion from FY 2004 through FY 2013. (See Figure
5.) By FY 2013, net physical capital stock would be almost $17
trillion, roughly 2 percent above baseline projections. For this
same 10-year period, the Economic Growth Package is projected to
lower the user cost of capital by an average of 4.0 percent
compared to the baseline forecast.
Fiscal Effects of the Entire Economic
The economic analysis in this report is based initially on
conventional, or static, estimates of the fiscal effects of the
proposed tax law changes. This method assumes that federal tax
policy does not affect economic growth and has been used by the
Joint Committee on Taxation (JCT) and the Congressional Budget
Office. Because the static approach does account for some of the
ways taxpayers alter their tax reporting and filing in
response to changes in tax law, it provides an excellent starting
point for performing dynamic analysis.
For example, a static estimate might include the effects of
taxpayers' shifting compensation from taxable to tax-exempt (or
tax-deferred) forms in response to certain tax law changes.
However, it does not take into account the way investors and
workers alter their consumption, investment, saving, and work
effort in response to changes in tax policy. Such
changes in taxpayers' behavior could affect important macroeconomic
variables, including employment, personal income, and GDP.
Therefore, the CDA extends the static approach by also using a
dynamic model to analyze the effects of tax policy proposals. For
example, if a tax rate reduction were to strengthen national
economic growth, the resulting larger tax base could actually
increase tax collections, which could partially offset the
federal revenue reduction caused by the lower rate. The CDA's more
complete approach accounts for the interactions between these
economic and fiscal effects.
The CDA analysis shows that there can be a substantial
difference between dynamic and static estimates of the budgetary
effects for plans such as the Economic Growth Package.
Specifically, the CDA forecasts that:
Higher economic growth lowers the Treasury's static
revenue effect by 57 percent
Static estimates suggest that the Economic Growth Package
would reduce federal revenue by about $638 billion from FY 2004
through FY 2013. However, a more realistic
estimate is that the proposal would reduce federal revenue
during the period by a total of $274 billion. (See Figure 4.)
The difference between these static and dynamic estimates arises
because the improved economic growth caused by the President's plan
is projected to increase the number of workers and the overall
level of income. These increases result in an expanded tax base and
higher tax collections than would be predicted using a static
approach. (See Table2c.)
A federal surplus will be maintained within the 10-year
On-budget, the federal government is projected to move from
deficit to surplus within the 10-year budget window. By 2013, the
federal on-budget surplus is projected to be more than $337
billion. Off-budget, the federal government is projected to
maintain a surplus throughout the 10-year budget window. (See Table
The Possibility of "Crowding Out"
The "crowding out theory" of budget deficits suggests that
higher government debt will lead to higher interest rates and
reduced economic growth. According to this theory, government
budget deficits shrink the supply of credit in private
markets. This reduction in supply, in turn, leads to higher
prices--interest rates--in private credit markets.
Nonetheless, historical evidence suggests that "crowding out"
effects are rather negligible as long as fiscal policies do not
produce large economic imbalances, such as extremely high
debt-to-GDP ratios. The projected average debt-to-GDP ratio in the
CDA analysis is not high by historical standards, suggesting that the benefits
of implementing the Economic Growth Package should far
outweigh any corresponding negative crowding out effects.
Furthermore, the projections indicate that the plan's long-term
economic growth would achieve an on-budget federal surplus within
the 10-year budget window and maintain an off-budget surplus
throughout the 10-year window.
COMPARISON WITH OTHER PLANS
Some legislators have called for tax cuts lasting two years or
less and tax rebates in order to increase consumption and move the
economy out of a slow-growth phase. However, such
calls for temporary tax cuts and rebates ignore the bulk of
economic theory on lifetime consumption and the recent experience
with tax rebates. Both have indicated that rebates and other
temporary tax reductions are generally not consumed as if they
were ordinary income. Instead, they are used to reduce debt or
increase saving--an effect precisely the opposite of the one
The Economic Growth Package, however, would more likely be
perceived as providing long-term reductions in marginal tax rates.
These long-term reductions, consequently, are more likely to be
viewed by economic agents as a permanent increase in income.
Taxpayers benefiting from long-run, rather than temporary, tax
relief are likely to spend their increased disposable income at the
same rate as they do the rest of their personal income. More
important, lowering marginal tax rates provides individuals with a
higher after-tax return on working and saving by allowing them to
keep more of the next dollar they earn.
CDA analysts used the DRI-WEFA model to examine the difference
between temporary and long-term tax reductions. The model was used
to estimate the effects of Senator Thomas Daschle's proposal (S.
414), which employs one-year, targeted tax cuts to boost
economic growth. This analysis suggests that
the Daschle plan would create fewer jobs and less GDP than the
President's proposal, particularly in the long run. For
example, the CDA projects that the Daschle plan would add
545,000 jobs by the end of calendar year 2003, far less than the
844,000 jobs projected for the Bush plan in calendar year 2003. The 10-year averages for
growth in jobs and GDP under the two plans exhibit an even greater
For instance, for calendar years 2004 through 2013, the Daschle
plan is projected to bring about an average increase of 22,100
jobs. On the other hand, the President's Economic Growth Package is
estimated to add an average of 787,000 jobs for calendar years 2004
through 2013. Over the same 10-year period, the Bush plan is
projected to provide an average of $69 billion in additional
GDP, while the Daschle plan adds only an estimated $3.4 billion to
COMPARISON WITH OTHER FORECASTS
Simulations of the President's proposal have been performed by
several other groups, including the Business Roundtable (BRT), Decision Economics (DE),
Global Insight (GI), and Macroeconomic Advisers (MA). This
section compares the CDA forecast to the forecasts of these other
groups. Table 1 summarizes these
In general, the results of the simulations agree that the
President's Economic Growth Package would bolster economic and
employment growth in the early years. However, the CDA and BRT
simulations find sustained improvement, while the GI and MA
simulations find that the plan's benefit would decline after the
initial years. The two forecasts finding sustained improvement
take account of both the demand-side and supply-side effects of the
plan, while the two finding declining improvement take account
principally of the plan's demand-side effects.
Aggregate Demand vs. Aggregate
The BRT appears to have focused on both short-term demand and
long-term supply-side incentives. For instance,
John J. Castellani notes that "The dividend component of this
package is the key driver of economic growth, as it will
consistently and continually pump fuel into the economy
over the long-run." In fact, BRT's forecasted
levels of GDP and employment remain well above baseline in both the
short and long terms, with larger increases in the first two years.
The CDA, the only other group that focused on both demand and
supply-side incentives throughout the 10-year budget window,
forecasted trends similar to those projected by BRT.
In contrast, GI and MA both appear to have focused more on
demand-side consequences rather than supply-side incentives. For
example, GI states that "In our model, the policy works its magic
mainly through stimulating consumption, although it also gives
investment in equipment and software a modest short-term boost." Similarly, MA states that
"Initially the plan would stimulate aggregate demand
significantly by raising disposable income, boosting equity values,
and reducing the cost of capital. However, the tax cut also reduces
national saving directly while offering little new, permanent
incentive for either private saving or labor supply."
Comparisons of Economic Effects
The average inflation-adjusted additional GDP forecasted for FY
2003 through FY 2007 by the CDA and GI is $61.0 billion and $65.5
billion, respectively. (See Table 1.) However, the annual average
additional GDP projected by GI and the CDA for the later years
exhibits a larger difference. From 2008 through 2012, the CDA and
GI project higher average GDP of $66.3 billion and $39.2
billion, respectively, above baseline.
MA reported GDP growth rates for select years from 2003 through
2017 but did not report the actual level of GDP forecasted for all
years. While MA forecasts GDP growth
rates below baseline for several years, there is no way to
determine, based on the reported information, whether the actual
level of GDP is above or below baseline. The CDA's forecasted GDP
growth rates, for instance, are below baseline by 0.2 percentage
point in 2006 and 0.1 percentage point in 2007, while its projected
level of real GDP is above baseline by $68 billion in 2006 and $61
billion in 2007.
Another key economic variable to compare is the level of
employment. The average numbers of additional jobs forecasted for
calendar years 2003 through 2007 by the CDA and GI are 763,000 and
708,000, respectively. Yet the averages projected for the years
2008 through 2012 by the CDA and GI are 200,800 and 354,000,
respectively. As a result, GI's forecasted average job growth for
2003 through 2012 is lower than the CDA's estimate: 531,000 versus
BRT, the only other group to mention strong supply-side effects
explicitly in its analysis, projects employment growth similar to
that forecasted by the CDA for the long term. For calendar
years 2008 through 2012, BRT forecasts an average of 700,000
additional jobs, almost twice as high as GI's calendar years 2008
through 2012 estimate. The unemployment rate reported by MA also
suggests that they focused more heavily on demand-side
consequences, reporting an unemployment rate below baseline
through 2007 but above baseline from 2008 through 2017.
Comparisons of Fiscal Effects
Both GI and the CDA project a similar dynamic federal revenue
reduction in the earlier years of the 10-year budget window. For
example, from FY 2003 through FY 2007, the CDA and GI forecast a
dynamic federal revenue reduction of $241 billion and $219 billion,
respectively. However, from FY 2008 through FY 2012, the CDA and GI
project a federal revenue reduction of $53 billion and $170
billion, respectively. Similar patterns also exist in the estimated
effects on the federal surplus.
For FY 2003 through FY 2007, the CDA and GI project reductions
in the federal surplus of $332 billion and $310 billion,
respectively. From FY 2008 through FY 2012, however, the CDA and GI
estimate reductions in the federal surplus of $239 billion and $430
billion, respectively. Furthermore, from calendars years 2003
through 2007, BRT and MA forecast dynamic federal surplus
reductions of $262 billion and $311 billion, respectively.
Federal Reserve Reaction
The CDA assumed that the President's proposal would not
significantly interfere with the Federal Reserve's goal of
maintaining price stability in a growing economy. GI,
however, modeled a non-accommodating Federal Reserve response,
meaning that the Fed raised interest rates soon after the
implementation of the plan and continued to do so in several of the
Also, in the short run, MA held the nominal money supply to
baseline, allowing "changes in fiscal stimulus to be reflected in
GDP." In the long run, however, MA
modeled a rise in interest rates as a pro-cyclical response to
higher economic growth. Consequently, both GI and MA projected that
the Federal Reserve would raise interest rates in response to
higher economic growth, thus stifling employment and GDP.
Dividend Payout Ratio
The CDA and BRT followed U.S. Department of the Treasury
estimates, increasing the dividend payout rate by 2 percentage
points above the baseline in 2004 and 4 percentage points
above baseline from 2005 through 2013. GI, on
the other hand, did not assume "any increase in dividend payout
above what the model wants to give."
Due mainly to its elimination of the double tax on corporate
dividends, the President's Economic Growth Package is projected to
increase the number of workers and the overall level of income
in the United States throughout the next 10 years. Relative to the
baseline forecast, from 2004 through 2013, the CDA forecasts that
GDP would average an additional $69 billion, employment would
average an added 844,000 jobs, and disposable income would
average an additional $121 billion. Consequently, this higher
economic growth would result in an expanded tax base,
suggesting that the true federal revenue reduction would be
only about $274 billion--far less than the U.S. Treasury's static
estimate of $638 billion.
William W. Beach is
Director of, and Ralph A. Rector, Ph.D., is
Research Fellow and Alfredo Goyburu and Norbert J. Michel are
Policy Analysts in, the Center for Data Analysis at The
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.