included in this report
Table 1: The Economic Effects of the Katrina Emergency Tax
Relief Act of 2005
has dealt a serious blow to the Gulf Coast and New Orleans. Initial
estimates from state and local authorities suggested that losses of
human life could approach or even exceed levels last seen in the
wake of the 1900 hurricane that destroyed Galveston, Texas.
Happily, those dire predictions have not come to pass, and
Katrina's death toll has thus far remained below 1,000.
But the economic
costs to the region are likely to be large. The federal government
has responded to Katrina and its aftermath with increased federal
spending and new proposals for tax relief. The first tax relief
measures considered by the U.S. House of Representatives (H.R.
3768, Katrina Emergency Tax Relief Act of 2005) and the U.S. Senate
(S.1696, Hurricane Katrina Tax Relief Act of 2005) are limited to
providing short-term emergency relief to persons affected by
Both measures seek to assist Katrina's victims by offering:
packages addressing the rebuilding efforts in New Orleans and along
the Gulf Coast are likely to be considered later this month.
An analysis of
H.R. 3768 as originally passed by the House of Representatives
shows that its short-run economic and budgetary effects are small
Relative to a baseline that takes account of Hurricane Katrina but
excludes any Katrina-related tax cuts:
(inflation-adjusted) gross domestic product (GDP) is an average of
$1.2 billion higher between 2006 and 2008;
personal consumption expenditures are an average of $1.6 billion
higher between 2006 and 2008; and
disposable personal income is an average of $2.8 billion higher
between 2006 and 2008.
provisions of H.R. 3768 are only temporary, its economic effects
are negligible over a 10-year (2006-2015) budget window. Similar
results would likely be obtained from an analysis of the version of
H.R. 3768 amended by the U.S. Senate on September 15.
effects of H.R. 3768 are also small over the 10-year budget window.
After accounting for the macroeconomic effects, H.R. 3768 reduces
unified federal tax revenues by roughly $3 billion (not
inflation-adjusted) between 2006 and 2015. It increases federal net
interest payments and, therefore, the unified federal deficit by
more than that $3 billion over the same period.
H.R. 3768's impact
on the unified deficit would have been even smaller (in our
analysis) if its provisions had been financed with spending cuts as
opposed to new deficits and debt. Its positive impact on GDP,
income, consumption, and other macroeconomic aggregates would
likely have been much smaller or even negative if its provisions
had been financed with increases in other taxes, particularly taxes
affecting business owners and investors.
The Economic Costs
of Hurricane Katrina
The economic costs
of Hurricane Katrina to New Orleans and the Gulf Coast are likely
to be large. For example, the Bureau of Labor Statistics (BLS) puts
total employment in the New Orleans-Metairie-Kenner metropolitan
statistical area at over 615,000 in 2004.
It puts the total employment in the 145,341 establishments in the
86 hardest hit counties (and parishes) in Mississippi, Alabama, and
Southern Louisiana at 2.4 million, or 1.9 percent of total U.S.
employment, in 2004.
As a result of flooding and evacuations, employment in New Orleans
and most its suburbs is likely to fall sharply, at least through
Employment outside the hardest hit areas of New Orleans is likely
to be less severely affected and to rebound more quickly.
arising from Katrina are also likely to be considerable. The four
hurricanes to strike Florida in 2004 and the World Trade Center
attacks in 2001 resulted, respectively, in over $23 billion and
$32.5 billion in privately insured damage/property losses. In
comparison, recent estimates of privately insured damage due to
Katrina range from $40 billion to $60 billion.
Even so, the
economic effects of natural disasters are not typically felt
outside the affected region. Katrina is likely to be different. The
damage sustained by the region's energy and port
infrastructure and the flooding of New Orleans is widely expected
to cause ripple effects throughout the national economy, at least
in the short run.
Hurricane Katrina temporarily knocked out roughly 10 percent of
U.S. refining capacity and 18 percent of U.S. crude oil production.
The impact on energy prices was almost immediate, with the U.S.
retail price of gasoline topping $3 per gallon by Labor Day.
Retail gas prices have since fallen, thanks to fast progress in
reopening refineries and restarting pipelines, but Katrina is
expected to fuel higher energy prices and consumer price index
inflation through the end of 2005.
government forecasters also expect Katrina to dampen overall real
(inflation-adjusted) economic growth. Global Insight has downgraded
its forecast for real U.S. GDP growth by 0.7 percentage points (to
3.2 percent) for the second half of 2005. The Congressional Budget
Office (CBO) anticipates that Katrina could reduce the growth rate
of real U.S. GDP by 0.5 to 1 percentage point over the same
Provisions of the
Katrina Emergency Tax Relief Act of 2005 (H.R. 3768)
Both H.R. 3768 (as
originally passed by the House of Representatives and later amended
by the Senate) and S.1696 are broadly similar. To boost disposable
income, both measures temporarily:
deductibility of personal casualty losses,
Provide a longer
period of time to use insurance proceeds to replace damaged
property without incurring tax,
Extend the work
opportunity tax credit to those hiring workers from affected
victims from taxes on forgiveness of debt by corporate lenders,
penalty-free withdrawals from retirement plans to provide hurricane
victims access to their saving.
In addition, H.R.
3768 gives displaced persons the option of using 2004 income to
calculate the child credit tax credit and the earned income tax
credit on 2005 returns.
The key provisions
of H.R. 3768 as passed by the House of Representatives are as
deductibility of personal casualty losses. The most costly part
of H.R. 3768 provides assistance to taxpayers who claim itemized
deductions and would otherwise be subject to certain limitations on
the deductibility of personal casualty losses. Under current law,
taxpayers are usually allowed a deduction for losses that are not
offset by insurance coverage or other forms of compensation.
However, only personal casualty or theft losses that exceed $100
are included in the total loss, and the deductible amount is only
that portion of the total loss that exceeds 10 percent of adjusted
gross income (AGI). The proposal allows taxpayers to include
individual losses less than $100 in the calculation of the total
when the separate losses are attributable to Hurricane Katrina. In
addition, all losses attributable to Hurricane Katrina are
deducible, not just the portion that exceeds 10 percent of AGI.
period for replacement of damaged property. The second most
costly element of the proposal provides a longer period of time for
taxpayers to replace damaged property without having the
replacement increase their tax liability. Under current law, gains
from the sale of property are generally calculated by subtracting a
basis value from the sales price. However, special rules now allow
the gain to be deferred or exempt from taxation but only if the
property replacement occurs within a limited period of time. The
proposal modifies these rules by increasing the replacement period
to five years if the property is located in a designated area and
if the replacement is associated with Hurricane Katrina.
the work opportunity tax credit. Current law provides a work
opportunity tax credit (WOTC) for employers that hire individuals
who are from specific target groups.
H.R. 3768 creates a new target group for certain individuals who
lived in the Hurricane Katrina disaster area on August 28, 2005.
The provision applies only when the principal place of employment
is within the Katrina disaster area and is limited to work that
begins during a two-year period starting on August 29, 2005.
provisions. H.R. 3768 relaxes some of the current-law
limitations on the amount of charitable contributions that can be
deducted. It also suspends the inclusion of Katrina-related debt
forgiveness (such as cancellation of mortgage debt) for purposes of
calculating taxable income and allows qualified taxpayers with
individual retirement accounts, pensions, or other types of
retirement programs to withdraw a maximum of $100,000 without
paying the 10 percent penalty that would otherwise be due.
Budgetary Effects of H.R. 3768
short-term U.S. Macroeconomic Model is used to analyze the
immediate economic and budgetary impacts of H.R. 3768.
(See Table 1.) The
results, expressed relative to a baseline that includes Hurricane
Katrina but excludes any of the newly proposed tax cuts, show
(inflation-adjusted) GDP increases by $1.9 billion in fiscal year
2007. It climbs an average of $1.2 billion between 2006 and
consumption expenditures are $2.2 billion higher in 2007. They are
an average of $1.6 billion higher between 2006 and 2008.
personal income is $3.8 billion higher in 2007. It is an average of
$2.8 billion higher between 2006 and 2008.
employment increases by a modest 16,000 jobs in 2007. It climbs an
average of almost 11,000 jobs between 2006 and 2008.
Because the tax
relief provisions of H.R. 3768 are only temporary, any economic
gains arising from them are short-lived. Thus, by 2015, real GDP,
personal consumption, disposable personal income, and total
non-farm employment have all roughly returned to base levels. Over
the 10-year budget window (2006-2015), the average effects of H.R.
3768 on all four economic indicators are negligible. That said, any
positive economic impacts derived from H.R. 3768 would likely have
been much smaller or even negative (in our analysis) if its
provisions had been financed with increases in other taxes,
particularly taxes affecting business owners and investors.
Such results are
not entirely unexpected. Tax incentives broadly stimulate economic
activity through one of two channels. Tax cuts aimed at permanently
lowering the cost of capital can encourage new investment. In the
long run, the resulting increase in the economy's stock of
productive capital raises productivity and the rate of economic
growth. Long-run gains in incomes and employment are a natural
result. Tax cuts aimed at only temporarily raising disposable
personal income boost consumption and output in the short run.
However, they do little to spur new business spending on capital
goods or to boost long-term hiring or improve the economy's
long-run rate of potential growth.
economic effects of H.R. 3768 are also limited in part by its
provisions to extend the replacement period for damaged property.
Joint Committee on Taxation (JCT) estimates of the revenue effects
of H.R. 3768 put revenue losses from this provision at $1.9 billion
over fiscal years 2006 through 2008.
However, the JCT estimates revenue gains from the same provision in
every year from 2009. In aggregate, H.R. 3768 raises taxes in every
year after 2010. As a result, disposable personal income and
personal consumption are slightly below base levels in the later
effects of H.R. 3768 are small. Between 2006 and 2015, H.R. 3768
reduces unified federal tax revenues by just under $5.3 billion
(not inflation-adjusted) as estimated by the JCT and by roughly $3
billion (not inflation-adjusted) on a fully dynamic basis.
The simulations assume that provisions in H.R. 3768 are financed
not with spending cuts, but rather with new deficits and debt. As a
result, federal net interest payments rise, and the unified federal
deficit increases by a total of almost $8.5 billion over the
10-year budget window. H.R. 3768's impact on the unified deficit
would likely have been smaller if its provisions had been financed
at least in part with spending cuts.
September 2005 U.S. Macroeconomic Model was used to analyze the
economic and budgetary effects of H.R. 3768.
Analysts in the Heritage Foundation's Center for Data Analysis
(CDA) typically use a version of the Global Insight model that has
been calibrated to the most recent CBO baseline economic and
budgetary assumptions and forecasts. However, for this analysis,
CDA's CBO-like baseline model could not be updated to reflect the
effects of Katrina in the time available. As a result, Global
Insight's September model, which takes Katrina into account, was
Unlike a CBO-like
baseline model and forecast, Global Insight's baseline model and
forecast do not embody current-law assumptions about changes in tax
policy and government spending.
For example, a current-law baseline forecast would assume the
expiration by 2010 of all components of the Economic Growth and Tax
Relief Reconciliation Act (EGTRRA) of 2001 and the Jobs and Growth
Tax Relief Reconciliation Act (JGTRRA) of 2003. It would also
exclude any new legislation increasing federal spending, even when
such legislation is likely to be enacted. In contrast, Global
Insight's September 2005 baseline forecast assumes that not all
components of EGTRRA and JGTRRA expire as currently scheduled. It
also explicitly includes $100 billion in new federal spending for
the Federal Emergency Management Agency and for the rebuilding of
infrastructure in New Orleans and along the Gulf Coast.
procedure was followed in analyzing the economic and budgetary
effects of H.R. 3768. First, estimates of the changes in tax
revenues stemming from H.R. 3768's general tax relief provisions
were taken from JCT estimates.
Average effective federal personal income tax rates in the Global
Insight model were then adjusted to target JCT estimates of
aggregate revenue losses and gains between 2006 and 2015. Second,
the implied changes in average effective personal income tax rates
were introduced into the Global Insight model. CDA analysts assumed
that the tax cuts implied by H.R. 3768's general provisions were
not offset by cuts in federal spending.
In addition, CDA
analysts assumed that the Federal Reserve Board would follow
historical patterns of behavior when reacting to a change federal
spending and taxes. This assumption was implemented in the Global
Insight model using an econometrically estimated reaction function
that determines the effective interest rate on federal funds.
Foertsch, Ph.D., is a Senior Policy Analyst and Ralph A. Rector,
Ph.D., is a Research Fellow and Project Manager in the Center for
Data Analysis at The Heritage Foundation.