INTRODUCTION
On November 6, 2001, Senate Majority Leader Thomas Daschle
(D-SD) reaffirmed his intention to introduce a two-component
economic stimulus package that would combine the plans of Senators
Max Baucus (D-MT) and Robert Byrd (D-WV). It now appears likely
that the upcoming Senate debate on economic stimulus legislation
will center around Senator Daschle's plan and a plan proposed by
Senator Charles Grassley (R-IA) that is strongly supported by
President Bush.
Although both plans are intended to ease the impact of the the
economic recession and improve the incentives to work, save, and
invest (the real catalysts for economic growth), there are
substantial fiscal policy differences between them. On the one side
are those, led by the President and Senator Grassley, who believe
that vigorous tax cuts combined with limited spending increases
will do the most to lift the economy out of its current slump. On
the other side are those, led by Senator Daschle, who believe that
substantial spending increases combined with limited, targeted tax
cuts will do the most to remedy the economic problems worsened by
the September 11 attacks.
This Report addresses the question of which approach-significant
tax cuts with limited spending or significant spending with limited
tax cuts-would do more to boost the economy. It evaluates both of
the Senate stimulus plans, using the same economic model, against
the same baseline, to determine which approach would produce the
best economic results over the next five years.
Analysts in the Heritage Foundation's Center for Data Analysis
(CDA) used the WEFA U.S. Macroeconomic Model, the Center's
Individual Income Tax Model, and work by the staff of the Joint
Committee on Taxation to address this question. Specifically, CDA
economists estimated the economic effects of the Bush-Grassley plan
and Daschle plan using the same model of the U.S. economy, one that
contains a two-quarter recession beginning in the third quarter of
2001 and ending during the first quarter of 2002. This analysis
shows that:
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In FY 2002, the Bush-Grassley plan
produces nearly twice as many jobs as the Daschle plan does
(211,000 vs. 108,000). From FY 2002 to FY 2006, on average, the
Bush-Grassley plan produces over 7 times more jobs than the Daschle
plan (283,000 per year vs. 38,000 per year). (
See attached
table)
-
From FY 2002 to FY 2006, the
inflation-adjusted disposable income of an average family of four
would increase by an average of $1,060 per year under the
Bush-Grassley plan and by only $236 per year under the Daschle
plan.
-
In FY 2002, the Bush-Grassley plan
increases inflation-adjusted consumption expenditures by $27.9
billion - 28 percent more than the $20.0 billion increase under the
Daschle plan.
-
By the end of FY 2002, the average
savings for a family of four (adjusted for inflation) would
increase by $752 under the Bush-Grassley plan, compared with an
increase of $536 under the Daschle plan.
-
From FY 2002 to FY 2006, the nation's
(inflation-adjusted) investments would increase by an average of
$13.4 billion per year under the Bush-Grassley plan and by only
$1.1 billion per year under the Daschle plan.
Although both plans transfer income to low- and moderate-income
taxpayers through rebates and both assist the unemployed, the fact
that the economic outcomes produced under the Daschle plan fall far
short of those produced under the Bush-Grassley plan raises serious
questions about the utility of cash payments and increased
government spending as the primary tools for boosting economic
activity. The better approach would be to lower tax rates and the
tax burden on labor and capital to improve incentives for workers
and business owners, producing more jobs and generating higher
incomes, which, in turn, translate into higher investment and
consumer spending.
SUMMARY OF PLANS
CDA analysts evaluated two economic stimulus plans for this
Report: the plan proposed by Senator Charles Grassley and strongly
supported by President Bush, and the plan proposed by Senator
Majority Leader Thomas Daschle that would combine the plans of
Senators Max Baucus and Robert Byrd.
The Bush-Grassley plan consists of five elements: individual
income tax reductions, tax policy changes that reduce capital
costs, cash relief to low- and middle-income workers, extending and
expanding unemployment insurance, and expanding health insurance
coverage. The plan is expected to result in static federal revenue
reductions and spending increases totaling $248 billion over next
five years. Specifically, Senator Grassley and the President
propose:
·
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Accelerating into 2002 all of the tax
rate reductions that are currently scheduled for 2004 and
2006;
-
Accelerating the depreciation of
capital acquisitions for the next three years by enacting a 30
percent "bonus" depreciation for those years;
-
Repealing the corporate alternative
minimum tax on a prospective basis;
-
Providing supplemental cash payments
to taxpayers who were not qualified to receive the full amount of
last summer's tax rebates ($300 for singles, $600 for married
taxpayers, and $500 for head-of-household taxpayers);
-
Establishing a temporary emergency
extended unemployment compensation program to provide an additional
13 weeks of unemployment benefits to workers laid-off as a result
of the September 11 attacks;
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Providing states with $3 billion in
National Emergency Grants to pay for unemployment insurance
benefits to laid-off workers not eligible for the temporary
extended benefit program, to pay up to 75 percent of health
insurance premiums covered by CORBA, and to strengthen job
placement assistance; and
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Encouraging states to use $11 billion
in unspent S-CHIP matching funds to expand health insurance
coverage for the uninsured.
The Daschle plan consists of five elements: cash relief to low-
and middle-income workers, tax policy changes that reduce capital
costs, extending and expanding unemployment insurance, expanding
health insurance coverage, and significantly increasing spending
for infrastructure and national security projects. The key contrast
between the Bush-Grassley plan and the Daschle plan centers on the
amount of tax relief vs. the amount of increased spending that each
provides. Specifically, the Daschle plan would consist of:
-
Supplemental tax rebate checks for
taxpayers who did not receive the full amount during the summer of
2001;
-
A 10 percent "bonus" depreciation for
investment in capital and software placed in service over the next
12 months;
-
Expansion of Section 179 expensing
for small businesses;
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Expansion of the carryback period for
Net Operation Loss Carrybacks;
-
Extension of expiring tax
credits;
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Temporarily extending and expanding
Unemployment Insurance;
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Subsidized COBRA coverage;
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Expansion of Medicaid to cover the
unsubsidized portion of COBRA coverage; and
Significant spending increases for agriculture, highway
projects, transportation security, border security, bioterrorism
prevention, and state and local anti-terrorism grants.
The Daschle plan would reduce federal tax revenue and increase
spending by a total of $88 billion over the next five years.
COMPARISON OF ECONOMIC EFFECTS
There may be many good political reasons for Congress to pass an
economic stimulus package, but there is one overriding economic
reason: the intervention should improve the incentives to work,
save, and invest--the real catalysts of economic growth. Fiscal
policy changes that focus on these economic incentives will lay the
foundation for stronger economic growth and reduce the depth and
shorten its duration of the current slowdown. Indeed, the competing
stimulus plans should be evaluated with respect to their effects on
depth and duration of the recession as much as, or more than, with
respect to any other criteria.
To determine how the two plans compare in terms of their effect
on the expected depth and duration of the current recession, CDA
analysts developed projections of the economic impact of each of
the plans. The chart below shows how each plan will affect the
change in employment between the beginning of the recession (the
end of the second quarter of 2001) and the time when total
employment returns to the level it would likely have attained had
their not been the recession of 2001 (i.e. the first quarter of
2004). This chart shows that, while both proposals lessen the depth
of job loss, only the Bush-Grassley plan significantly shortens the
time before employment regains the level it would have attained
without a recession. As Chart 1 shows, the Bush-Grassley plan
reduces the employment trough by nearly 33 percent and shortens the
length of the job slowdown by six months.
Both plans affect economic activity but the Bush-Grassley plan,
which contains significant tax relief and limited spending,
produces uniformly better economic results than a plan based on
substantial spending increases combined with limited tax cuts. For
example, in FY 2002:
-
The Bush-Grassley plan would produce
nearly two times the number of jobs than the Daschle plan would
(211,000 vs. 108,000).
-
Under the Bush-Grassley plan, the
inflation-adjusted disposable income of an average family of four
would increase by $1,176, compared with $844 under the Daschle
plan.
-
The Bush-Grassley plan increases
inflation-adjusted consumption expenditures by $27.9 billion - 28
percent more than the $20.0 billion increase under the Daschle
plan.
-
The average savings for a family of
four (adjusted for inflation) would increase by $752 under the
Bush-Grassley plan and by only $536 under the Daschle plan.
-
The Bush-Grassley plan would increase
inflation-adjusted investment by $7.8 billion, compared with a $4.9
billion increase under the Daschle plan.
Moreover, as the attached
table shows, the differences in the effects of the two
plans will be even more pronounced in future years. The
Bush-Grassley stimulus package creates more jobs, provides more
income to families and does a better job expanding economic
activity than the Daschle plan. These differences become more
dramatic as the pro-growth elements of the Bush-Grassley plan take
hold. On average, from FY 2002 to FY 2006:
-
The Bush-Grassley plan produces 7
times the number of jobs than the Senate plan does (283,000 per
year vs. 38,000 per year).
-
The inflation-adjusted disposable
income of an average family of four would increase by $1,062 per
year under the Bush-Grassley plan and by only $236 per year under
the Daschle plan.
-
The Bush-Grassley plan increases
inflation-adjusted consumption expenditures by $45.4 billion per
year, compared with an increase of only $10.3 billion per year
under the Daschle plan.
-
Personal savings (adjusted for
inflation) would increase by $27.3 billion per year under the
Bush-Grassley plan and by only $5.4 billion under the Daschle
plan.
-
The Bush-Grassley plan would increase
inflation-adjusted investment by $13.4 billion per year, while the
increase under the Daschle plan would be only $1.1 billion per
year.
CONCLUSION
The two economic stimulus plans analyzed in this Report clearly
reflect the two major views of government's role in economic
planning. On the one hand, the Bush-Grassley approach primarily
relies on changes in the tax rates on capital and labor to boost
economic performance. By lowering tax rates and the tax burden on
investment and capital assets, this supply-side plan provides
incentives for business owners and workers, producing more jobs and
generating higher incomes, which translate, in turn, into greater
investment and consumer spending.
On the other hand, Senator Daschle's demand-side approach
principally relies on cash transfers to displaced workers and
distressed businesses to stimulate economic activity. While this
plan produces some increase in employment and income and is better
than doing nothing, it fails to substantially increase the
fundamental incentives for stronger economic activity. In fact, the
Senator's plan never creates the large consumer response that would
be needed in order for a demand-side, expenditure-based stimulus
proposal to produce the job and income increases that are generated
by supply-side proposals. While both plans transfer income to low-
and moderate-income taxpayers through rebates and both assist the
unemployed, the fact that the economic outcomes produced under the
Daschle plan fall far short of those produced under the
Bush-Grassley plan raises serious questions about the utility of
cash payments and increased government spending as the primary
tools for boosting economic activity.
William W.
Beach is Director of the Center for Data Analysis at The
Heritage Foundation; D. Mark Wilson is a
Research Fellow in the Thomas A. Roe Institute for Economic Policy
Studies at The Heritage Foundation; Rea S. Hederman is
Manager of Operations for, and Ralph Rector is a
Research Fellow in, the Center for Data Analysis at The Heritage
Foundation.
APPENDIX A: METHODOLOGY
Heritage Foundation economists in the Center for Data Analysis
(CDA) followed a two-step procedure in analyzing the budgetary and
economic effects of the two stimulus plans evaluated by this
Report.
-
First, preliminary static tax revenue
estimates for the economic stimulus plan were generated by either
the Center's Individual Income Tax Model or obtained from the Joint
Committee on Taxation (JCT). The CDA and JCT tax revenue estimates
are based on a static methodology that generally does not account
for the macroeconomic effects that would result from a reduction in
tax rates. These effects include changes in gross domestic product
(GDP), interest rates, employment, personal income, and inflation
that can significantly affect tax revenues. Therefore, the static
estimates provide a very limited analysis of the economic and
budgetary impact of any policy change. To forecast the change in
federal tax revenue, spending, and the economy more accurately, a
dynamic model must be used.
Static fiscal year revenue estimates for tax rate changes were
computed using the CDA Individual Income Tax Micro-simulation
model. This model estimates the change in tax liability for a
national sample of over 100,000 tax filers. The sample contains tax
return data from the Public Use Tax File that is produced by the
IRS. In addition, the sample contains demographic and other
information from the Census Bureau's Current Population Survey.
Economic data from the CBO August 2001 forecast were used to
project the sample data forward to 2011.
- Second, the static revenue changes were introduced into the
WEFA U.S. Macroeconomic Model. The WEFA model is a dynamic model of
the U.S. economy designed to estimate how the general economy is
reshaped by policy reforms, such as tax law and spending changes.
Heritage economists developed a revised WEFA model for Heritage
work that embodies the economic and budgetary assumptions published
by the Congressional Budget Office (CBO) in August 2001, the recent
increases in federal spending, and the latest Blue Chip forecast
for economic growth following the September 11 terrorist attacks.
This specifically adapted WEFA model produces dynamic responses
from the modified CBO baseline as a result of the proposed policy
changes.
THE
SIMULATION
The WEFA model contains a number of variables that are used to
simulate proposed policy changes. The following sections describe
how the CDA static estimates were introduced into the WEFA model to
estimate the dynamic economic and budget results.
Average Effective Personal Income Tax Rate.
The WEFA model contains a variable that measures the total
amount of all federal taxes on individual income as a percentage of
the nominal personal income tax base. Heritage economists adjusted
this average effective tax rate downward for each of the forecast
years to reflect the static revenue decrease estimates.
Average Effective Corporate Tax Rate.
The WEFA model contains a variable that measures the total amount
of federal corporate tax revenue as a percentage of nominal
corporate profits. Heritage economists adjusted this average
effective tax rate downward for each of the forecast years to
reflect the static revenue decrease estimates.
Labor Force Participation and Average Weekly Hours.
Small adjustments were made in the model's exogenous labor force
participation rate and in the number of hours worked to account for
the dynamic effects of accelerating the marginal income tax rate
reductions.
Business Sector Price Index.
The business sector price index was reduced to reflect the lower
tax rates on business income that would be reported on personal
income tax forms.
Corporate AAA Bond Rate.
The corporate AAA bond rate was reduced to reflect the lower tax
rates on business (capital) income in the three plans.
Government Transfers.
The WEFA model contains variables that measure the amount of
federal transfers to persons. Heritage economists increased these
amounts to reflect the tax rebates, unemployment insurance
benefits, and any other transfers to persons in the three
plans.
Government Grants to States.
The WEFA model contains variables that measure theamount of
federal grants to states. Heritage economists increased these
amounts to reflect any increased spending on medical insurance and
other state grants in the three plans.
Government Spending.
The WEFA model contains variables that measure the amount of
federal defense and non-defense spending. Heritage economists
increased these amounts to reflect any increased spending in the
three plans.
Monetary Policy.
The model assumes that the Federal Reserve Board will react to
this policy change as it has historically. This assumption was
embodied in the Heritage model simulation by including the
stochastic equation in the WEFA model for monetary reserves.