- This brief reports Penn Wharton Budget Model’s (PWBM) dynamic analysis of the Tax Cuts and Jobs Act (TCJA), which complements our static analysis previously released.
- PWBM’s dynamic analysis finds that, depending on parameter values, the bill lowers tax revenues between $1.4 trillion to $1.7 trillion over 10 years while increasing federal debt between $2.0 trillion and $2.1 trillion over the same time period. By 2040, debt is between $6.3 trillion and $6.8 trillion higher than otherwise.
- TCJA raises GDP in 2027 between 0.33% and 0.83% relative to its projected value in 2027 with no policy change. However, this small boost fades over time, due to rising debt. By 2040, GDP may even fall below current policy’s GDP.
The House Tax Cuts and Jobs Act: Dynamic Effect on the Budget and the Economy
Penn Wharton Budget Model’s (PWBM) static analysis found that the Tax Cuts and Jobs Act (TCJA)1 reduces federal revenues in the short- and long-run. Our static analysis also discusses the reforms included in TCJA. This brief uses the PWBM to report the projected impact that the bill will have on the economy and federal budget, including revenues and debt held by the public.
PWBM’s Dynamic Model
The dynamic version of PWBM is based on an overlapping-generations (OLG) model where households maximize their welfare in a forward-looking manner. The OLG model allows households to respond to policy changes by altering their economic choices – labor supply, consumption and saving. These feedback effects may reinforce or offset the direct effects of tax policy changes on the size of the economy, economic growth, distribution of income and federal revenues.
Integration between PWBM’s dynamic model and static model is achieved by first running the OLG model in “static” mode and then running the model in “dynamic” mode. The differences between the two are then layered on top of the static microsimulation results. This approach captures the richness of detail in the microsimulation model along with the behavioral changes observed in the OLG model.
As discussed in previous analysis, PWBM’s Tax Policy Simulator allows for two different assumptions on the initial rate of return on capital: (a) a “high” return, where the return to capital is assumed to be the marginal product of capital net of depreciation, and (b) a “low” return, where the return to capital is assumed to be close to the risk-free (Treasury bill) rate. A “high” rate of return produces macroeconomic results that are generally more favorable for tax cuts. However, the “low” return assumption is generally more consistent with existing tax law that allows for tax loss offsets, which means that the tax on the “equity premium” portion of the marginal product of capital is effectively risk shared with the government. For corporations, the “low” return is more applicable. For entrepreneurs, where reselling tax losses is more challenging, an argument can be made for focusing on the higher initial return, although other tax law provisions, such as IRS 83(b) election, provide additional benefits. We sidestep this issue by reporting our results as a range across both assumptions.
Budget Effects of the Tax Cuts and Jobs Act
Table 1 shows that, over the 10-year budget window, the Tax Cuts and Jobs Act is projected to reduce federal tax revenues between $1.4 trillion (high initial return to capital) to $1.7 trillion (low initial return to capital). Debt rises by more, by about $2.0 trillion, over this period due to debt services. By 2040, revenue falls between $3.7 trillion and $4.5 trillion, whereas debt increases by $6.3 trillion to $6.8 trillion.
Table 1: TCJA Effects on Revenue and Debt Relative to Current Policy
|Revenue (billions of $)||Debt (billions of $)|
|Years||High return to capital||Low return to capital||High return to capital||Low return to capital|
Note: The above estimates focus on the official definition of “revenue” and, therefore, do not incorporate tax refunds, which are recorded as outlays. As a result, the 10-year revenue loss of $1,811 billion shown above is $61 billion larger than shown in our previous static analysis that incorporates refunds as is consistent with JCT’s methodology. Debt rises faster than lost revenue due to debt service.
Economic Effects of the Tax Cuts and Jobs Act
The Tax Cuts and Jobs Act has effects beyond federal revenues, including effects on debt, GDP, labor income and U.S. capital services. These effects are presented in Figures 1 through 5.
Figure 1: Federal Tax Revenue Under Tax Cuts and Jobs Act With High and Low Return to Capital
Figure 2: Federal Debt Held by the Public Under Tax Cuts and Jobs Act With High and Low Return to Capital
Figure 3: Gross Domestic Product Under Tax Cuts and Jobs Act With High and Low Return to Capital
Figure 4: Labor Income Under Tax Cuts and Jobs Act With High and Low Return to Capital
Figure 5: Capital Services Under Tax Cuts and Jobs Act With High and Low Return to Capital
Table 2 summarizes the results. By 2027, GDP is between 0.33% and 0.83% larger than current policy in that year. However, this initial boost fades over time as more debt accumulates. By 2040, GDP is between -0.25% and 0.41% larger than current policy in that year.
Table 2: TCJA Effects on Key Macroeconomic Variables Relative to Current Policy in Year Shown
|GDP (% change)||Labor Income (% change)||Capital Services (% change)|
|Year||High return to capital||Low return to capital||High return to capital||Low return to capital||High return to capital||Low return to capital|
Consistent with our previous dynamic analysis and the empirical evidence, the projections above assume that the U.S. economy is 40% open and 60% closed. Specifically, 40% of new government debt is purchased by foreigners. To show the sensitivity of our results to this assumption, Table 3 considers two extreme cases: 100% open (consistent with a small open economy) and 0% open (consistent with a closed economy, maybe due to trade restrictions). In general, the combination of a higher initial return to capital and more openness (fewer trade barriers) leads to more economic growth than a lower return which also dampens the revenue effects of tax cuts.
Table 3: Sensitivity of Dynamic Results to “Openness” of the Economy
|10 Year Revenue (billions of $)||GDP relative to 2027 (% change)|
|High return to capital||Low return to capital||High return to capital||Low return to capital|
Penn Wharton Budget Model’s dynamic analysis projects that the Tax Cuts and Jobs Act reduces federal tax revenue in both the short- and long-run relative to current policy. In the near term, there is a small boost to GDP, but that increase diminishes over time.
Year,Current Law,Dynamic Low Rate of Return,Dynamic High Rate of Return 2016,3318.764,3318.764,3318.764 2017,3438.958,3438.95,3438.95 2018,3595.593,3347.106,3364.285 2019,3733.549,3519.518,3536.536 2020,3962.472,3759.808,3778.639 2021,4077.394,3886.658,3906.977 2022,4186.49,4003.69,4025.207 2023,4304.727,4205.257,4228.933 2024,4443.577,4354.841,4380 2025,4607.435,4485.084,4511.418 2026,4785.021,4636.894,4664.562 2027,4943.502,4770.248,4799.399 2028,5097.531,4914.712,4945.268 2029,5334.823,5143.747,5176.353 2030,5517.49,5324.007,5358.359 2031,5722.073,5522.234,5558.697 2032,5938.067,5732.125,5770.671 2033,6095.544,5887.223,5927.796 2034,6275.205,6060.157,6102.856 2035,6501.969,6282.137,6327.499 2036,6743.465,6514.788,6563.177 2037,6923.028,6691.259,6742.127 2038,7092.348,6857.516,6910.938 2039,7322.454,7086.811,7143.418 2040,7511.951,7273.357,7333.44
Year,Current Law,Dynamic Low Rate of Return,Dynamic High Rate of Return 2016,14334.72,14334.72,14334.72 2017,15055.84,15055.84,15055.84 2018,15886.63,16141.98,16134 2019,16870.4,17355.17,17339.45 2020,17955.3,18665.83,18641.04 2021,19214.11,20146.44,20111.56 2022,20607.92,21762.22,21716.25 2023,22169.1,23468.05,23409.1 2024,23910.53,25350.72,25277.35 2025,25796.44,27416.06,27327.33 2026,27844.65,29676.76,29571.58 2027,30071.73,32150.33,32027.14 2028,32467.6,34811.66,34669.13 2029,35058.14,37686.34,37522.59 2030,37841.18,40766.32,40579.85 2031,40815.83,44055.98,43844.92 2032,43960.36,47529.64,47292.12 2033,47313.19,51225.79,50959.78 2034,50891.86,55166.54,54870.08 2035,54699.87,59354.84,59025.28 2036,58756.29,63813.86,63448.44 2037,63027.27,68499.75,68096.36 2038,67560.23,73464.84,73020.97 2039,72395.34,78747.99,78260.63 2040,77532.91,84350.87,83816.72
Year,Current Law,Dynamic Low Rate of Return,Dynamic High Rate of Return 2016,18624.5,18624.5,18624.5 2017,19341.35,19341.35,19341.35 2018,20169.53,20272.85,20357.39 2019,20948.38,21061.14,21149.28 2020,22006.79,22117.95,22212.51 2021,22745.31,22850.59,22951.45 2022,23412.72,23512.02,23618.2 2023,24198.41,24291.76,24404.04 2024,24992.21,25085.69,25203.27 2025,25943.04,26037.97,26163.23 2026,26897.92,26993.08,27124.67 2027,27795.03,27888.12,28025.96 2028,28616.13,28704.16,28848.87 2029,29884.99,29968.13,30121.39 2030,30900.51,30976.06,31138.11 2031,31991.41,32058.15,32229.66 2032,33179.72,33237.11,33417.75 2033,34133.36,34179.09,34368.92 2034,35177.36,35208.64,35410.13 2035,36470.3,36485.82,36699.29 2036,37789.69,37786.55,38013.68 2037,38933.4,38909.66,39149.35 2038,40003.17,39955.92,40209.38 2039,41450.13,41375.14,41643.85 2040,42688.56,42580.12,42865.66
Year,Current Law,Dynamic Low Rate of Return,Dynamic High Rate of Return 2016,11248.6,11248.6,11248.6 2017,11654.04,11654.04,11654.04 2018,12175.01,12160.47,12211.44 2019,12701.09,12766.4,12816.95 2020,13425.96,13488.88,13543.9 2021,13973.9,14033.48,14093.33 2022,14505.64,14561.82,14625.57 2023,15118.21,15171.32,15239.55 2024,15718.08,15771.18,15843.8 2025,16396.99,16451.21,16528.8 2026,17056.44,17110.72,17193.23 2027,17654.21,17706.99,17793.86 2028,18175.74,18225.01,18316.47 2029,18981.66,19027.37,19125.48 2030,19626.68,19668.02,19770.68 2031,20319.57,20354.69,20464.13 2032,21074.33,21103.38,21218.74 2033,21680.04,21701.03,21822.73 2034,22343.15,22355.24,22483.94 2035,23164.37,23165.81,23303.46 2036,24002.39,23991.13,24137.56 2037,24728.83,24704.44,24859.19 2038,25408.3,25369.33,25532.33 2039,26327.35,26269.68,26443.02 2040,27113.95,27035.37,27219
Year,Current Law,Dynamic Low Rate of Return,Dynamic High Rate of Return 2016,100,100,100 2017,101.0875,101.0875,101.0875 2018,104.2759,105.2798,106.5506 2019,106.7604,107.6313,108.9946 2020,108.9984,109.8062,111.254 2021,113.4821,114.2274,115.7891 2022,113.6284,114.2947,115.9005 2023,115.8428,116.4367,118.115 2024,117.5815,118.1702,119.9223 2025,119.5369,120.1369,121.9537 2026,122.3987,123.0016,124.8971 2027,124.5781,125.1433,127.1205 2028,126.5747,127.086,129.1359 2029,127.9876,128.4311,130.5378 2030,132.7226,133.0844,135.312 2031,133.5402,133.8108,136.0959 2032,136.9883,137.1608,139.5409 2033,139.3613,139.4129,141.8859 2034,140.6416,140.5651,143.1064 2035,142.9926,142.7646,145.403 2036,146.1299,145.738,148.483 2037,148.7665,148.1748,151.027 2038,150.4223,149.6202,152.5759 2039,152.0428,151.0022,154.0654 2040,155.7647,154.4261,157.6576