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Analysis of "Tax Reform 2.0"

Analysis of "Tax Reform 2.0"
  • Recently, the House Ways and Means Committee introduced “Tax Reform 2.0” that includes new incentives to start up a business, enhanced savings accounts and makes permanent the individual tax cuts in the 2017 Tax Cuts and Jobs Act.

  • In April of 2018, PWBM anticipated and estimated the effects of the largest piece of this legislation that makes the TCJA individual tax cuts permanent.

  • This brief updates that analysis for the new 10-year budget window and incorporates the rest of the provisions in “Tax Reform 2.0.”

Penn Wharton Budget Model's Social Security Simulator

Penn Wharton Budget Model's Social Security Simulator

Click Here for Interactive Simulation

  • Penn Wharton Budget Model’s updated Social Security Simulator allows users to build Social Security reform plans to see the budgetary and economic impact of those plans.

  • Users can try up to 648 different policy combinations.

  • The model can handle a much wider range of Social Security policy options, which are not shown to conserve space. Policymakers, major media outlets and thought leaders who want to test different Social Security reforms can contact us for estimates.

Social Security’s Worsening Financial Condition

Social Security’s Worsening Financial Condition
  • Since the major Social Security reforms were passed in 1983, Social Security Trustees have slowly reduced their projected Social Security trust fund exhaustion date from at least 2058 to 2034. Yet, Trustees’ estimates still don’t incorporate key future macroeconomic variables, including the nation’s growing debt.

  • Using a model that incorporates future macro-economic forces, PWBM projects that the Social Security trust fund depletes in 2032. More importantly, we project much larger future annual cash-flow shortfalls. Relative to the payroll tax base, we project a cash-flow shortfall in 2032 that is 36 percent larger than the Trustees’ estimate for that year. By 2048, our projected cash-flow shortfall is 77 percent larger.

  • If Social Security shortfalls continue to contribute to the federal government’s unified deficits, consistent with no changes in taxes or benefits, we project that the federal debt-to-GDP ratio will exceed 200 percent by 2048, a path that is not sustainable.

Projecting the Mass Conversion from Pass-Through Entities to C-Corporations

Projecting the Mass Conversion from Pass-Through Entities to C-Corporations
  • We project that the Tax Cuts and Jobs Act (TCJA) will cause 235,780 U.S. business owners---77 percent of whom have incomes of at least $500,000---to switch from pass-through entity owners to C-corporations, primarily to take advantage of sheltering their income from tax by converting to C-corporations.

  • The biggest switchers include doctors, lawyers and investors, especially if owners can afford to defer receipt of business income to a later year. Other business owners, who are qualified to use the 20 percent deduction for pass-through business income, including painters, plumbers, and printers, are more likely to remain as pass-through entities.

  • We project that about 17.5 percent of all pass-through Ordinary Business Income will switch to C-corporations.

The Jobs and Infrastructure Plan for America’s Workers

The Jobs and Infrastructure Plan for America’s Workers
  • Senate Democrats propose spending $1,022 billion on public infrastructure over the next 10 years, financed with taxes on personal income and corporate income.

  • An additional dollar of federal aid could lead state and local governments to increase total infrastructure spending by less than that dollar since state and local governments can often qualify for the new grant money within their existing and planned infrastructure programs. Based on an extensive literature review, we estimate that infrastructure investment across all levels of government increases between $225 billion and $1,039 billion, including the $1,022 billion federal investment.

  • Depending on how much state and local governments spend on infrastructure in response to federal aid, we estimate that the plan changes GDP between -0.1 and 0.1 percent by 2032 relative to no policy change. By 2042, the plan changes GDP between -0.3 and -0.2 percent.

The Tax Cuts and Jobs Act: Extending Changes to Individual Taxes

The Tax Cuts and Jobs Act: Extending Changes to Individual Taxes
  • PWBM previously analyzed the effects of the tax bill passed this December. Most of that bill’s tax cuts for individuals (non-businesses) expire at year-end 2025. This brief reports the budgetary and economic effects of indefinitely extending the individual-side tax cuts.

  • By 2027, we project that debt increases between $573 billion and $736 billion. However, GDP is relatively unchanged, although slightly contracts, because this standard 10-year budget window covers only two years of tax cut extensions.

  • By 2040, we project that GDP contracts by 0.6 percent to 0.9 percent relative to current law, where the tax cuts for individuals are set to expire. Debt increases between $5.2 trillion and $6.1 trillion.

Options for Universal Basic Income: Dynamic Modeling

Options for Universal Basic Income: Dynamic Modeling
  • Public support for a Universal Basic Income (UBI) has been increasing over time, and several experiments are already underway.

  • The Roosevelt Institute recently published an analysis of a UBI proposal that would pay $6,000 per year to every adult in the United States. Roosevelt estimates that GDP would increase by up to 6.8 percent within eight years after the policy’s onset, if the policy were deficit financed.

  • We estimate the impact of the same plan on the federal budget and economy using a richer dynamic model. If deficit financed, we project that same UBI plan would increase federal debt by over 63.5 percent by 2027 and by 81.1 percent by 2032. GDP falls by 6.1 percent by 2027 and by 9.3 percent by 2032. The smaller tax base also sharply reduces Social Security revenue, by 7.1 percent by 2027 and by 10.4 percent by 2032.

The Omnibus Spending Bill of 2018

The Omnibus Spending Bill of 2018
  • Recently, President Trump signed the Omnibus Spending Bill of 2018 into law. The bill increases the level of federal discretionary spending in 2018.

  • This report projects the impact on the economy assuming that the increase to spending levels will be sustained in future years and evolve with PWBM’s demographic and macroeconomic projections.

  • By 2027, we project that debt increases by 1.6 percent and GDP falls by 0.1 percent, relative to current spending levels. By 2037, debt increases by 1.6 percent and GDP falls by 0.2 percent.

The Economic Costs of a Trade War

The Economic Costs of a Trade War
  • Major U.S. trading partners have already indicated they might retaliate to new U.S. trade tariffs recently announced by President Trump. New tariffs could, therefore, lead to a “trade war.” However, game theory also suggests that U.S. trading partners could eventually respond with “trade opening,” depending on the ultimate payoffs to each party in the trading partnerships.

  • We estimate that an all-out trade war would reduce GDP by 0.9 percent by 2027 and by 5.3 percent by 2040. Wages would decline by 1.1 percent by 2027 and 4.8 percent by 2040, relative to current policy. A trade opening would have the opposite effect: GDP would increase between 0.2 to 0.7 percent by 2027 and between 1.3 to 4.0 percent by 2040. Wages would increase between 0.3 to 0.8 percent by 2027 and between 1.2 - 3.6 percent by 2040, relative to current policy.

  • The downside risk of a trade war, therefore, is larger than the upside potential from a trade opening.

The White House FY 2019 Infrastructure Plan

The White House FY 2019 Infrastructure Plan
  • President Trump recently released his updated infrastructure plan along with the Fiscal Year 2019 Budget. The plan proposes to increase federal infrastructure investment by $200 billion to provide incentives for a total new investment of $1.5 trillion in infrastructure.

  • However, based on previous experience reviewed herein, most of the grant programs contained in the infrastructure plan fail to provide strong incentives for states to invest additional money in public infrastructure. Indeed, an additional dollar of federal aid could lead state and local governments to increase infrastructure total spending by less than that dollar since state and local governments can often qualify for the new grant money within their existing infrastructure programs. We estimate that infrastructure investment across all levels of government would increase between $20 billion to $230 billion, including the $200 billion federal investment.

  • We estimate that the plan will have little to no impact on GDP.

Options for Infrastructure Investment: Dynamic Modeling

 Options for Infrastructure Investment: Dynamic Modeling
  • President Trump proposes to increase infrastructure investment by $1.5 trillion over 10 years by attaching incentives to $200 billion of new federal spending. However, this plan lacks details about implementation. We, therefore, consider three possible options.

  • By 2027, we estimate that GDP is between 0.0 and 0.5 percent larger than under current law, depending on which one of the three policy options is used. By 2037, GDP is between 0.0 and 0.4 percent higher.

  • By 2027, debt held by the public is between 0.4 and 0.9 percent larger than under current law. By 2037, debt is between 0.4 percent lower and 0.6 percent larger.

Changes to Federal Infrastructure Spending in the White House FY 2018 Budget

Changes to Federal Infrastructure Spending in the White House FY 2018 Budget
  • The White House Fiscal Year 2018 Budget proposes spending $200 billion in new federal spending over 10 years to stimulate a total new infrastructure investment of $1 trillion.

  • However, separately, other changes to infrastructure programs in the budget propose to reduce federal spending between $185 billion to $255 billion over the next 10 years, depending on whether certain changes are temporary or permanent.

  • On net, therefore, the White House 2018 Budget proposes changing federal infrastructure spending between -$55 billion to $15 billion over 10 years.

The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Tax Effects by Industry

The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Tax Effects by Industry
  • The current U.S. statutory corporate tax rate is 35 percent. However, due to various deductions, credits and income deferral strategies, most corporations pay a lower rate, known as the effective tax rate (ETR), which averages about 23 percent under current law across all industries over the next decade. However, this value varies considerably across industries, with mining paying 18 percent and agriculture paying 33 percent.

  • The TCJA reduces the statutory corporate tax rate from 35 to 21 and the average ETR falls from 21 to 9 percent in 2018. However, by 2027, the ETR doubles in value to 18 percent, mostly due to expiring provisions.

  • In the short run, the biggest winners of the TCJA are capital-intensive industries like utilities, real estate and transportation, which benefit the most from temporary expensing of equipment. However, over time, several industry ETR’s will actually rise above the new statutory rate of 21 percent in future years.

The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Static and Dynamic Effects on the Budget and the Economy

The Tax Cuts and Jobs Act, as Reported by Conference Committee (12/15/17): Static and Dynamic Effects on the Budget and the Economy
  • By 2027, under our standard economics assumptions, we project that GDP is between 0.6 percent and 1.1 percent larger, relative to no tax changes. Debt increases between $1.9 trillion and $2.2 trillion, inclusive of economic growth.

  • By 2040, we project that GDP is between 0.7 percent and 1.6 percent larger under our baseline assumptions, and debt increases by $2.2 to $3.5 trillion.

The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17): Static Distributional Analysis

The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17):  Static Distributional Analysis
  • Under standard assumptions, the traditional measure indicates that in 2019, 33 percent of the reduction in taxes in the Senate plan accrues to households in the top one percent of the income distribution. By 2027, this group receives almost 43 percent of the tax change and, by 2040, 48 percent.

  • In contrast, the share of taxes paid by households in the top one percent of the income distribution is only moderately lower under the Senate TCJA. Under current policy, the top one percent will pay 28 percent of federal income taxes by 2027, rising to 30 percent by 2040 due to increasing progressivity over time under current policy. Under TCJA, their tax share falls to 26 percent by 2027 and returns to 28 percent by 2040.

  • By 2040, the top one percent will pay a slightly larger share of the nation’s tax base under TCJA relative to what they pay today under current policy, although both figures round to 28 percent.

The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17): Static and Dynamic Effects on the Budget and the Economy

The Senate Tax Cuts and Jobs Act, as Passed by Senate (12/2/17): Static and Dynamic Effects on the Budget and the Economy
  • By 2027, under our standard economics assumptions, GDP is projected to be between 0.5 percent and 1.0 percent larger, relative to no tax changes. Debt increases between $1.8 trillion and $1.9 trillion, inclusive of economic growth.

  • By 2040, GDP is projected to be between 0.4 percent and 1.2 percent larger under our baseline assumptions, and debt increases by $2.6 to $3.1 trillion.

  • Additional sensitivity analysis indicates that even under assumptions favorable to economic growth, by 2027, GDP is projected to be between 1.0 percent and 1.9 percent larger, and debt increases between $1.5 trillion and $1.8 trillion.

The Child Tax Credit: Options for Expansion

The Child Tax Credit: Options for Expansion
  • This brief compares the Child Tax Credit (CTC) expansion plans in the House tax bill, the Senate tax bill and the Rubio-Lee proposal.

  • The Penn-Wharton Budget Model projects the House CTC plan costs $373 billion, the Senate CTC plan, as passed by committee, costs $557 billion, and the Rubio-Lee proposal costs $742 billion over 10 years.

  • In terms of distributional impact, the House CTC plan increases benefits for middle income families. The Senate CTC plan, as passed by committee, increases benefits for lower income families, doubles benefits for middle income families and increases benefits from $0 to $2,000 for higher income families. However, the Senate CTC plan never reaches its maximum refundable amount of $2,000 due to sunset provisions. The Rubio-Lee proposal reaches $2,250 in 2025 before returning to current law value of $1,000 in 2026.

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): Comparing Dynamic Effects Estimated by PWBM & JCT

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): Comparing Dynamic Effects Estimated by PWBM & JCT
  • This brief compares Penn Wharton Budget Model’s (PWBM) dynamic projections (which include economic feedback effects) of The Senate Tax Cuts and Jobs Act (TCJA) against the recent projections issued by the Joint Committee on Taxation. The results are substantially similar.

  • Both PWBM and JCT find that the Senate TCJA reduces tax revenues by about $1 trillion over the next 10 years, net of outlays. PWBM’s and TCJA’s 10-year revenue estimate (net of outlays and interest) differs by only $3 billion. Both PWBM and JCT project that the economy under the Senate TCJA plan will be 0.8% larger on average over the first 10 years relative to current policy.

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): The Byrd Rule

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): The Byrd Rule
  • To use the reconciliation process that allows certain bills to pass with a simple majority vote in the Senate, the Senate Tax Cuts and Jobs Act (amended) must satisfy the Byrd Rule.

  • PWBM projects that the Senate bill will satisfy one part of the Byrd rule, as the 10-year net revenue shortfall will be less than $1.5 trillion in the associated budget resolution.

  • However, the Byrd Rule also requires that bills do not reduce net revenue (revenue net of outlays) after the 10-year budget window. Thus far, government scorekeepers have not weighed in on the Rule publicly. PWBM, however, projects that the provisions in the Senate TCJA will reduce net revenue in each year from 2028 to 2033 and will therefore fail the Byrd Rule.

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): Dynamic Effects on the Budget and the Economy

The Senate Tax Cuts and Jobs Act, Amended (11/15/17): Dynamic Effects on the Budget and the Economy
  • This brief reports Penn Wharton Budget Model’s (PWBM) dynamic analysis of The Senate Tax Cuts and Jobs Act (TCJA), as amended with sunset provisions on November 15, 2017.

  • If the sunset provisions are allowed to expire as scheduled, including economic feedback effects, revenue falls between $1.3 trillion and $1.5 trillion over the 10-year budget window, ending in 2027. Debt increases between $1.4 trillion and $1.6 trillion, which is larger than the revenue losses due to additional debt service. By 2040, revenue falls between $1.1 trillion and $2.1 trillion, while debt increases by $1.7 to $2.4 trillion.

  • PWBM projects that GDP will be between 0.3 percent and 0.8 percent larger in 2027 relative to no tax changes. By 2040, GDP is projected to be between 0.2 percent and 1.2 percent larger.