For additional details on TIPRA’s provisions, see Joint Committee on Taxation, “Estimated Revenue Effects of the Conference Agreement for the ‘Tax Increase Prevention and Reconciliation Act of 2005’,” JCX-18-06, May 9, 2006, at www.house.gov/jct/x-18-06.pdf (July 10, 2006).
The Global Insight model is used by private-sector and government economists to estimate ways in which important changes in the economy and public policy are likely to affect major economic indicators. It contains several policy variables that can be used to simulate changes in tax policy. The methodologies, assumptions, conclusions, and opinions presented here are entirely the work of analysts at The Heritage Foundation’s Center for Data Analysis. They have not been endorsed by, and do not necessarily reflect the views of, the owners of the Global Insight model.
For additional information on EGTRRA’s expiring provisions, see Joint Committee on Taxation, “Summary of Provisions Contained in the Conference Agreement for H.R. 1836, The Economic Growth and Tax Relief Reconciliation Act of 2001,” JCX-50-01, May 26, 2001, at www.house.gov/jct/x-50-01.pdf (June 9, 2006).
For additional details on CBO’s January 2006 baseline projections, see Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 to 2016, January 2006, at www.cbo.gov/ftpdocs/70xx/doc7027/01-26-BudgetOutlook.pdf (May 1, 2006). For a summary of the rules governing CBO’s current-law federal budget baseline, see Christopher Williams, “What Is a Current-Law Economic Baseline?” Congressional Budget Office Economic and Budget Issue Brief, June 2, 2005, at www.cbo.gov/ftpdocs/64xx/doc6403/EconomicBaseline.pdf (August 7, 2006).
In Table 1, inflation adjustment accounts for small differences between projections of the pre-EGTRRA tax brackets and the extension plan tax brackets. In law, the base amount for the widths of the 25 percent, 28 percent, 33 percent, and 35 percent brackets do not change.
For additional details on our calibration procedure, see Tracy L. Foertsch and Ralph A. Rector, “Calibrating Macroeconomic and Microsimulation Models to CBO’s Baseline Projections,” The IRS Research Bulletin: Recent Research on Tax Administration and Compliance, Publication 1500, forthcoming 2006. A more detailed working paper version of this publication is also available upon request.
Global Insight provided a detailed outline of a methodology for calibrating the GI model to CBO’s baseline projections. We created a series of programs to automate the process based on that outline, making adjustments and additions to GI’s basic methodology where appropriate. The routines are written in AREMOS, Global Insight’s proprietary modeling language.
GI’s February 2006 U.S. Macroeconomic forecast is used as the control. The February 2006 forecast is used because it was the first to include projections for 2016.
CBO published historical estimates of potential output since 1950, along with projections of potential output through 2011, in Robert Arnold, “CBO’s Methods for Estimating Potential Output: An Update,” A Congressional Budget Office Paper, August 2001, at www.cbo.gov/ftpdocs/30xx/doc3020/PotentialOutput.pdf (June 11 2006).
CBO publishes its projections of NIPA taxable personal income in the January release of The Budget and Economic Outlook. See Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 to 2016, January 2006, Table 4-3, p. 86.
For its August 2006 economic and budgetary projections, CBO published for the first time details about how it forecasts the components of gross domestic income. See Angelo Mascaro, “How CBO Forecasts Income,” Congressional Budget Office Background Paper, August 2006, at www.cbo.gov/ftpdocs/75xx/doc7507/08-25-Income.pdf (August 29, 2006).
Contributions for federal social insurance are also included in NIPA federal tax receipts. They are set to CBO’s baseline revenue projections in step 1.
For CBO’s projections of individual capital gains realizations, see Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 to 2016, January 2006, Table 4-4, p. 92.
The Global Insight model defines corporate (book) profits as GNP net of consumption of fixed capital, taxes on production and imports, transfer payments by business, interest payments by business, net surpluses of government enterprises, employer-paid payroll taxes, wage and salary income, other labor income, proprietors’ income, personal rental income, and the statistical discrepancy.
Gross tax return income here refers to a broad income measure that approximates the Internal Revenue Code’s definition of gross income reported on Form 1040.
We obtain projections of capital gains realizations from Congressional Budget Office, The Budget and Economic Outlook: Fiscal Years 2007 to 2016, January 2006, Table 4-4, p. 92. We develop independent estimates for the remaining non-NIPA sources of personal income.
In estimating detailed personal income targets, we rely upon unpublished tables comparing the components of NIPA personal income and Internal Revenue Service (IRS) federal adjusted gross income. Those tables are available from the Bureau of Economic Analysis (BEA) upon request. We also rely upon annual Survey of Current Business articles describing the major categories used to reconcile the differences between personal income and federal AGI. Additional details can be found in Mark A. Ledbetter, “Comparison of BEA Estimates of Personal Income and IRS Estimates of Adjusted Gross Income, New Estimates for 2001, Revised Estimates for 1959-2000,” Survey of Current Business, April 2004, pp. 8–22, at www.bea.gov/bea/ARTICLES/2004/04April/0404PI&AG.pdf (May 31, 2006). For a summary of the most recent reconciliation of NIPA personal income and IRS federal AGI, see U.S. Department of Commerce, Bureau of Economic Analysis, National Income and Product Accounts, Table 7.19 (Comparison of Personal Income in the National Income and Product Accounts with Adjusted Gross Income as Published by the Internal Revenue Service), at www.bea.gov/bea/dn/nipaweb/SelectTable.asp?Selected=N#S7 (May 24, 2006). Table 7.19 appears periodically in the Survey of Current Business.
NIPA does not separately report the sum of gains and losses for proprietorships or other businesses. Losses are instead added to gains to derive an aggregate net amount of proprietorship income. This is problematic for purposes of estimating government revenues. Thus, we use IRS data to estimate the historical relationship between the aggregate amount of proprietors’ income and the amount of net gains and losses.
For example, see Tracy L. Foertsch and Ralph A. Rector, “Economic and Budget Effects of a Two-Period Revenue Neutral Flat Tax,” Unpublished Working Paper, August 2006.
In Table 2A, estimated changes in federal individual income tax revenues include net refundable credits.
Here, baseline revenue projections are the sum of CBO’s current-law projections of estate, business, and individual income tax revenues.
TIPRA increased the individual AMT exemption amount and continued the AMT’s unrestricted use of some nonrefundable personal tax credits through the end of calendar year 2006. Those credits include higher education credits and the child and dependent care credits.
As defined here, “claw back” is the result of a phaseout of the AMT exemption amount for taxpayers with high levels of AMT income. For additional details, see Gregg Esenwein, “The Alternative Minimum Tax (AMT): Income Entry Points and “Take Back” Effects,” Congressional Research Service Report for Congress, Order Code RS21817, February 10, 2005.
See U.S. Department of the Treasury, Office of Tax Analysis, “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief.” Permanently extending the 10-percent tax bracket, the $1,000 child tax credit, and marriage penalty relief has little effect on average effective marginal tax rates.
Business income here includes income from IRS Form 1040 Schedules C, E, and F.
The labor force participation rate is calculated by dividing the projected civilian labor force by the population aged 16 years and older. The increase in the labor force participation rate is forecast to average almost 0.2 percentage point in 2016.
We use an econometrically-estimated reaction function in the GI model that adjusts the effective interest rate on federal funds in response to changes in the unemployment rate and the rate of inflation in the CPI.
The AMT is nearly a flat tax with two brackets, 26 percent and 28 percent. See Gregg Esenwein, “The Alternative Minimum Tax (AMT): Income Entry Points and “Take Back” Effects,” Congressional Research Service Report for Congress, Order Code RS21817, February 10, 2005. For additional details on the impact of the AMT on average marginal tax rates and labor supply, see David Brauer, “CBO’s Projections of the Labor Force,” Congressional Budget Office Paper, September 2004, at www.cbo.gov/ftpdocs/58xx/doc5803/09-15-LaborForce.pdf (September 21, 2006). See also Joint Committee on Taxation, “Present Law and Background Relating to the Individual Alternative Minimum Tax,” JCX-37-05, May 20, 2005, at www.house.gov/jct/x-37-05.pdf#search=%22jct%20capital%20gains%20phase%20out%20range%22 (September 21, 2006).
We model refundable credits as a change in federal transfer payments to persons and, thus, a change in federal outlays.
A CBO memorandum puts the total wage elasticity for the population as a whole between 0 and 0.3. That total wage elasticity breaks down into a participation elasticity that falls between 0.1 and 0.2 and an average hours elasticity that does not exceed 0.1. See Frank S. Russek, “Labor Supply and Taxes,” Congressional Budget Office Memorandum, January 1996, at www.cbo.gov/ftpdocs/33xx/doc3372/labormkts.pdf (June 26, 2006). All labor supply elasticities are further multiplied by 0.25 to obtain a quarterly pattern. All implied reductions in labor force participation and average hours worked are phased in over two years.
See U.S. Department of the Treasury, Office of Tax Analysis, “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief,” Table 3, p. 20.
For a more detailed description of the treatment of the old and new views of the economic effects of dividends in macroeconomic models, see Ben Page, “How CBO Analyzed the Macroeconomic Effects of the President’s Budget,” A Congressional Budget Office Paper, July 2003, at www.cbo.gov/ftpdocs/44xx/doc4454/07-28-PresidentsBudget.pdf (May 16, 2006).
This analysis is based on a static comparison of the cost of equity under the extension plan and current law. The static analysis assumes that the extension plan has no effect on baseline levels of the economic and financial-market aggregates used to calculate the change in the value of the cost of capital and the S&P 500.
We use 10-year averages (1992–2002) for all publicly traded companies included in the Standard & Poor’s Compustat database. We assume that 46 percent of all dividends paid out by corporations are subject to personal income taxes. See William G. Gale, “About Half of Dividend Payments Do Not Face Double Taxation,” Tax Notes, November 11, 2002, p. 839.
An empirical literature links stock market reactions to capital gains tax policy. For a survey of empirical work on the impact of the 1997 Taxpayer Relief Act and the 1998 Internal Revenue Service Restructuring and Reform Act on equity values, see Douglas A. Shackelford, “Stock Market Reactions to Capital Gains Tax Changes: Empirical Evidence from the 1997 and 1998 Tax Acts,” Presented at the National Bureau of Economic Research Fall 1999 Conference on Tax Policy and the Economy, September 1999.
For example, see Margo Thorning, “Capital Gains Taxation and US Economic Growth,” Testimony before the Standing Committee on Banking, Trade and Commerce of the Senate of Canada, December 16, 1999, at www.accf.org/publications/testimonies/test-dec16-99.html. Alternatively, Shackelford, et al. examine the effects of personal capital gains taxation on asset prices in the period surrounding the announcement of TRA 97’s capital gains tax cuts. Their analysis incorporates both the demand-side capitalization effects and the supply-side lock-in effects of a change in the capital gains tax rate. Shackelford, et al. find evidence of initial price declines (a capitalization effect), followed by price increases after the official announcement of TRA 97’s cuts in the tax rate on capital gains (a lock-in effect). Their results are still tentative but seem to suggest that the two effects approximately offset one another. See Shackelford, et al., “Capital Gains Taxes and Asset Prices: Capitalization or Lock-in?,” February 16, 2006, at www.public.kenan-flagler.unc.edu/taxsym/Dai-DMSZ.pdf (June 26, 2006).
See James Poterba, “Taxation and Corporate Payout Policy,” National Bureau of Economic Research Working Paper 10321, February 2004, at www.nber.org/papers/W10321 (June 26, 2006). Poterba obtains this 6 percent estimate by using an S&P 500 price-earnings ratio to capitalize CBO projections of the annual flow of forgone dividend taxes.
See Alan J. Auerbach and Kevin A. Hassett, “The 2003 Dividend Tax Cuts and the Value of the Firm: An Event Study,” June 2005, at www.nber.org/papers/W11449 (June 26, 2006).
See Gene Amromin, Paul Harrison, Nellie Liang, and Steve Sharpe, “How Did the 2003 Dividend Tax Cut Affect Stock Prices and Corporate Payout Policy,” Finance and Economics Discussion Series, Divisions of Research and Statistics and Monetary Affairs, Federal Reserve Board, Working Paper No. 57, September 2005, at www.federalreserve.gov/pubs/feds/2005/200557pap.pdf (June 26, 2006).
See U.S. Department of the Treasury, Office of Tax Analysis, “A Dynamic Analysis of Permanent Extension of the President’s Tax Relief.” The OTA includes an analysis of the long-run dynamic economic effects of the President’s tax proposals.
For additional details, see John Diamond and George Zodrow, “Description of the Tax Policy Advisers’ Model,” Unpublished Working Paper, Rice University, March 15, 2005. The OTA uses a four-sector version of the Tax Policy Advisers’ overlapping-generations computable general equilibrium model.
This means that the model adjusts taxes or government consumption to hold the debt-to-GNP ratio constant at its 2017 value.
See Tracy L. Foertsch and Ralph A. Rector, “The Treasury Department’s Dynamic Analysis of President Bush’s Tax Relief Plan: A Summary and Evaluation,” Center for Data Analysis, CDA06-06, August 16, 2006, at www.heritage.org/Research/Taxes/cda06-06.cfm.
In Chart 2, estimated changes in federal individual income tax revenues exclude net refundable credits.
Thus, this $179.4 billion is the difference between revenue effects from the income-adjusted forecast (–$812.5 billion) and the baseline forecast (–$991.9 billion).