- Without more detail on the Republican plan, we cannot offer a firm estimate of its economic impact in either the short or long run. However, if what we do know of JTGA were enacted now, we would not materially change our forecasts for either economic growth or employment through 2013.
- If actually enforced in fiscal year (FY) 2012, a BBA would quickly destroy millions of jobs while creating enormous economic and social upheaval. However, we believe no responsible policymaker would push the implementation of a BBA when the projected federal deficit is $1 trillion and the Fed is unable to offset much fiscal drag.
- A BBA would amplify cyclical swings in the economy. Furthermore, it likely would be abandoned or circumvented with the first recession after ratification, creating confusion and uncertainty over fiscal policy.
- The proposed income tax reform is revenue neutral for both households and corporations and so, upon first consideration, implies little near-term impact on either aggregate demand or employment.
- However, if the burden of taxes shifts down the income distribution, or if the curtailment of interest deductions and depreciation allowances raise the cost of capital, there could be near-term drag on consumption or investment.
- The long-run impact of income tax reform cannot be properly assessed without additional details on the proposal.
- The near-term stimulus to employment or investment from repatriating earnings sooner than previously expected is negligible.
- The beneficial effects of fast-track trade authority cannot be quantified without knowing what agreements are fast-tracked. Moreover, there is bipartisan support for negotiating trade agreements beneficial to the U.S. economy.
- The impact of regulatory and energy proposals in JTGA is difficult to assess, but we are skeptical of claims for large near-term employment effects. Moreover, there is bipartisan support for reducing or delaying the burden of those regulations with adverse near-term impacts on growth and employment.
- Previously we reported our estimates that implementation of AJA would boost GDP growth by 1.3 percentage points over 2012 and raise employment 1.3 million by the end of next year.[2]
Demand, Supply, or Both?
In 2009, the Obama Administration released its own estimates of the impact of the American Recovery and Re-Investment Act. This time, it left analysis of AJA to the private sector and challenged Republicans to submit their plan to similar scrutiny. This is asking us to compare apples to oranges. AJA would boost aggregate demand and hence employment in the near term, pushing the economy towards full employment while also adopting programs to reduce “structural” unemployment. JTGA embodies policies more likely to work slowly through the supply side of the economy, not so much reducing current labor market slack as boosting labor productivity in the long run. So, while the enactment of JTGA might not compel us to change our near-term forecasts for growth and employment, it could encourage us to revise up modestly our projections of potential GDP, particularly if eventual details on tax reform imply strong incentives for labor supply and capital investment. In that sense, we view AJA and JTGA as potentially complementary in nature, not competitive.
Balanced Budget Amendment
The Republican call for a Balanced Budget Amendment is maddeningly vague in the operational details that could well doom it. Which definition of the budget? Is it the current deficit, the projected deficit, or even the structural deficit that is to be eliminated? Is balance in the budget required year by year or on average over the business cycle? What’s the enforcement mechanism? Would enforcement require spending cuts, tax increases, or some combination of both? Are there any contingencies (war, natural disasters, recessions, etc) for which the commitment is temporarily set aside? Even if we knew when a BBA might go into effect—and we have no idea, other than never—without these details we could not possibly simulate its impact.
We can, however, say this: the initial impact of a “hard” BBA on jobs would depend on the size of the deficit at the time when the amendment was first enforced. Suppose in 2008, when the deficit seemed manageable, a BBA had been sent by Congress to the states, that it was ratified this fall, and enforced for FY 2012. The effect on the economy would be catastrophic. Our current forecast shows a Unified Budget deficit of about $1 trillion for FY 2012. Suppose this fall the federal government enacted a budget for FY 2012 showing discretionary spending $1 trillion below our forecast, resulting in a “static” projection of a balanced budget for next year. $1 trillion is roughly two-thirds of all discretionary spending, and about 7% of GDP. Our short-run multiplier for discretionary spending is about 2, and let’s assume a simple textbook version of Okun’s law in which the unemployment gap varies inversely with, but by half as much as, the percentage output gap. Then, instead of forecasting real GDP growth of 2% or so for FY 2012, we’d mark that projection down to perhaps -12% and raise our forecast of the unemployment rate from 9% to 16%, or roughly 11 million fewer jobs. With interest rates already close to zero, the Fed would be near powerless to offset this huge fiscal drag.
And that would not be the end of it. Soon it would become obvious that revenues were falling far short of earlier static projections as both taxable income and average tax rates declined cyclically and mandatory spending increased cyclically as well. The induced rise in the deficit could come to $500 billion, requiring an additional $500 billion cut in discretionary outlays that would zero them out. (That’s right, zero them out!) This would cause another 5% decline in GDP and another other 4 million jobs lost, etc.
No model could capture the ensuing chaos and uncertainty, which would make matters far worse. We assume no policymaker faced with this economic reality would advocate implementing such policy. The pall of uncertainty cast over the economy if it appeared a BBA could be ratified and enforced in the middle of recession or when the deficit was still large would have a chilling effect on near-term economic growth. Indeed, the only way to implement a BBA without some fiscal drag is to ratify it when the budget is in balance or surplus. Of course, then we wouldn’t have needed the BBA to achieve balance in the first place.
Suppose the BBA was implemented when the budget already was in balance. There still would be new and powerful uncertainties in play. The economy’s “automatic stabilizers” would be eviscerated, discretionary counter-cyclical fiscal policy would be unconstitutional, and the sole responsibility for macroeconomic stabilization policy would rest with the Fed—perhaps at a time, like today, when the ability of the FOMC to offset fiscal drag is sharply curtailed by the proximity of interest rates to the zero bound. We believe this would change cyclical dynamics. Recessions would be deeper and longer. Furthermore, in our model, critical markers for financial conditions, like private credit spreads and the VIX, have important cyclical components, the magnification of which would further aggravate the business cycle. In all likelihood the effort to legislate fiscal morality with a simple rule would be overturned or suspended with the first big recession following ratification, creating new uncertainty about fiscal policy and the governance that produced the amendment in the first place.
The ultimate goal of a balanced budget amendment is to reduce the federal deficit. As we have written elsewhere, we believe strongly that deficit reduction is necessary both to avoid the slow crowding out of private investment and to avert the eventual sovereign debt crisis implied by current policies. A BBA would not necessarily achieve these goals before being abandoned or circumvented. Furthermore, an interesting and growing literature suggests that uncertainty surrounding fiscal policy retards economic growth.[3] The attempt to enforce a BBA could well end up heightening fiscal uncertainty while magnifying cyclical risks to the economy. It would be far better to achieve a sustainable fiscal policy through considered discretionary actions than under the yoke of a mechanical rule.
Tax Reform
JTGA, like many others current proposals, would reform the income tax code by curtailing or eliminating tax expenditures while lowering marginal tax rates enough to offset the “static” revenue gain of the base-broadening. The main argument for tax reform is that, over time, lower marginal rates will stimulate growth from the supply side of the economy by encouraging extra work, saving, and investment. In addition, a simpler code would cut compliance costs and increase efficiency by reducing tax-induced distortions in the allocation of resources.
JTGA describes the reform as revenue neutral (in static terms) separately for households and corporations. This implies no initial change in either personal disposable income or after-tax corporate profits, and hence no initial effect on aggregate demand. Any immediate impact on consumer spending would depend on distributional particulars not yet spelled out. However, we expect that reducing the top personal marginal rate from the current 36% to the proposed 25% implies some shifting of the personal tax burden from high-income taxpayers towards the middle class. If, as many economists believe, the propensity to consume is higher for the middle class, there could be some initial near-term drag on consumer spending associated with the reform. Distributional considerations also bear on the supply-side outcomes of tax reform. In particular, the effect on the labor force (which determines the long-run effect on “jobs”) depends on the outcome of a tug of war between income and substitution effects—not in the aggregate, but for cohorts differentiated by income, gender, education, and attachment to the labor force. Therefore, we need to know more about the changes in marginal and average tax rates faced by these groups before attempting to assess the effect of tax reform on labor supply and potential output.
On the corporate side, revenue neutrality could imply that lowering the marginal corporate tax rate from the current 35% to the proposed 25% is paid for by limiting current deductions for interest and depreciation. Even without such restrictions the impact on the cost of capital of lowering the corporate tax rate is ambiguous in sign because as the rate declines so does the after-tax value of deductions for interest and depreciation. Our own calculations suggest that if a reduction in the corporate rate is combined with elimination of the corporate deduction for interest and a shift from accelerated to economically neutral depreciation schedules, the cost of capital would rise, not fall. This raises the possibility of a near-term deceleration in fixed investment and calls into question one element of the supply-side rationale for the reform. Indeed, while an objective of tax reform is to encourage more work, saving, and investment with lower marginal rates, a fair question is: relative to what? In particular, tax reform could increase the top marginal rate on dividends and long-term capital gains to 25%, raising the personal marginal tax rate on capital income.
In the mid-1990s, Macroeconomic Advisers participated in a two-year exercise, sponsored by the Joint Committee on Taxation (JCT) that brought together modelers of all stripes in an effort to reach a consensus on the macroeconomic impacts of tax reform. There were lively arguments over the magnitude and direction of short-run demand effects, debates about how to characterize any monetary response, and considerable disagreement over the effects of tax reform on the labor force. Not surprisingly, then, there emerged from the discussion a range of estimates. However, a fair summary is that comprehensive tax reform would increase potential GDP modestly over several decades. There was also agreement that reforming the income tax would have a smaller effect on GDP than, say, replacing the income tax with a consumption tax. Considering all this, we feel comfortable arguing for many of the long-run benefits of reforming the income tax while not expecting much, if any, near-term boost to either GDP or employment. Still, to simulate either the short-run or long-run effects of tax reform more definitively, we need additional details on the proposal, ideally including a full work-up of the static distributional effects.
Repatriation of Profits
JTGA envisions a territorial tax code as part of tax reform. Over time, and in conjunction with the proposed lower corporate income tax rate, this could—provided other countries don’t “retaliate” somehow—encourage businesses to locate in the United States, incent U.S. multinationals to repatriate earnings, and “unlock” for immediate repatriation up to $1.4 trillion.
Any move of global business to the U.S. would take time, leaving as a candidate for near-term stimulus and job creation only the unlocking of foreign earnings for repatriation. One prominent Republican economist claims a “repatriation holiday” could boost GDP by $360 billion (roughly 2¼%), creating 2.9 million jobs.[4] We view such claims with extreme skepticism. Not surprisingly, following the repatriation holiday in 2004, multinational companies surveyed claimed to have spent large portions of the repatriated funds on hiring and capital investments. If true, this might imply that a repatriation holiday today would have a notable impact on aggregate demand. However, more rigorous empirical research suggests that most of the money repatriated then went towards dividend distributions and share re-purchases, which would have only indirect effects on aggregate demand.[5]
And we believe these effects would be negligible. For example, a “surprise” repatriation holiday might encourage companies to bring funds home sooner than previously planned in order to exploit the temporarily lower tax rate. There would occur an increase in the share price of firms with foreign earnings to repatriate that reflected the present discounted value of both the shifting forward of the repatriation and the temporarily lower rate at which those earnings were taxed. The JCT puts this (undiscounted) gain at between $70 and $80 billion, or less than 0.5% of the value of all corporate equity…not even a day’s variation in today’s volatile stock market.[6] Still, to follow the analysis through: in our model the marginal propensity to consume out of this equity gain would be about 5 cents on the dollar, or less than $4 billion in total spread out over a few years. Not much to talk about.
Furthermore, this is a lump sum payment from government to business predicated upon past economic activity. There would be no change in marginal incentives to hire or invest, and so no compelling reason for companies to use the temporary tax break to expand productive capacity with order books as thin as they are today.[7] Moreover, it is not the case that these multinationals are cash-constrained or lacking access to capital markets.
Regulatory Reform
JTGA would repeal both “Obamacare” and Dodd-Frank while rolling back or limiting many other current or pending regulations, typically by requiring analysis demonstrating the net benefit, often in terms of job creation, of the regulation in question. Republican talking points claim that Obamacare has reduced employment growth 90% by causing a “structural break in job growth” that already has destroyed 800,000 jobs; they also point to a study by the Financial Roundtable concluding that by 2015, Dodd-Frank will have cost 4.6 million jobs. The inference is that some Republicans believe repealing these two pieces of legislation alone will boost employment by more than 5 million in 2015. Add this together with the 2.9 million jobs for repatriation of profits, and you are up to 8 million – enough to reduce our forecast of the unemployment rate in 2015 from over 6% to only slightly more than 1%! Not surprisingly, we view such undocumented claims as, well, talking points.
Regulation does not prevent the economy from achieving full employment. After all, the economy wasn’t that much less regulated in 2007 when the unemployment rate was 4.5%, half of today’s reading. Regulation does require firms to combine labor and capital in a manner that results in less measured output (and higher prices) than otherwise, and that reduction in output can be reflected in lower profits, wage rates, or both. Furthermore, regulation can certainly alter the distribution of employment between industries and regions. There are, however, legitimate reasons for many regulatory requirements, including the discouragement of health and safety hazards and the reduction of systemic financial risk, the costs of which may not be fully reflected in prices posted in an unregulated market. Hence, it is important to recognize that jobs should not be the sole, even the main, criterion for assessing the value of a particular regulation.
Having said that, streamlining regulatory procedures, eliminating duplicative regulations (and regulatory bodies), sun-setting regulations that prove ineffective or have outlived their original purpose, and requiring cost-benefit analyses of proposed new regulations will increase productivity over time, even if the near-term effects on aggregate employment are second-order. It is hard to argue against this. The problem here is the difficulty of quantifying the productivity gain from many of the regulatory proposals included in JTGA. For example, we have no reliable way to measure the effects on national employment or overall productivity of preventing the EPA from tightening its regulation of dust in rural America.
Domestic Energy Promotion
JTGA contains several provisions intended to speed the exploration for and possible eventual production of domestic energy. For example, the talking points claim that, if enacted as part of JTGA, the Jobs and Energy Permitting Act (Senate bill 1226, sponsored by Senator Murkowski of Alaska) will create 50,000 jobs and increase oil production off the Alaskan Outer-Continental Shelf by 1 million barrels per day.[8] No timeline is offered for these increases. In principle, more exploration might spell higher employment in the industry and some eventual reduction in oil prices if exploration uncovers commercially exploitable reserves. However, the magnitude and timing of any such price decline is so speculative that we would not change our forecast of oil prices until the legislation was enacted, and even then only if we saw a notable drop in futures prices for crude oil around that time. Our expectation is that any such decline in price would occur at the back end of the futures curve, with little implication for real personal disposable income, and hence consumer spending, over the next several years. Similarly, it is very hard to assess other claims made in the talking points; for example, that preventing the EPA from regulating greenhouse gases under the Clean Air Act will save 1.4 million jobs by 2014, bringing the total number of jobs created or saved up to almost 9.5 million!
Export Promotion
JTGA would grant the President fast-track authority to negotiate trade agreements to reduce trade barriers and open new markets to American suppliers. The President also favors trade promotion, so there isn’t much here to differentiate the two plans. Furthermore, Congress recently passed three trade-related bills that had been on the docket a considerable period of time. It is not clear what could be negotiated next, or how quickly. We simply cannot quantify the beneficial effects of fast-track authority without knowing more about the trade agreements in question. And, in any event, our interpretation of the relevant empirical literature is that employment gains in domestic industries benefitting from trade agreements usually are modest, develop slowly over time, and may be partially offset by employment losses in other domestic industries that are adversely impacted.
Concluding Remarks: The "Right" Thing to Do?
In closing, we view the main thrust of the Jobs through Growth Act—deficit reduction, tax reform, regulatory relief, free trade, energy exploration—as long-run, supply-side policies the beneficial effects of which are more likely to be reflected in secular productivity gains than in near-term utilization rates for capital and labor. Indeed, there’s a sense here that JTGA is motivated by a belief that the plan is simply the right thing to do, irrespective of short-run effects and distributional consequences—some of which could be negative—and independent of any hard empirical estimates of the long-run benefits. In our judgment and apart from the BBA, the long-run objectives of the plan are not without merit, but it is a reach to argue that quick enactment of JTGA would significantly reduce the unemployment rate over the next year or two because, in our view, the plan does not address the root cause of today’s unemployment—namely, insufficient aggregate demand. In contrast, AJA would boost aggregate demand, but stakes little claim on long-run, supply-side effects. In that sense we view the two plans as more complementary in nature than competitive. If only Democrats and Republicans could see it that way, too!
[1] See http://mccain.senate.gov/public/index.cfm?FuseAction=PressOffice.PressReleases&&ContentRecord_id=feb4d840-c3be-83b1-a1fb-b7f2a039e94d
[2] See “The American Jobs Act: Greater than Expected,” Macroeconomic Advisers’ Macro Focus (Volume 6, Number 12), September 13, 2011.
[3] For example, see Jesús Fernández-Villaverde, Pablo Guerrón-Quintana, Keith Kuester, and Juan Rubio-Ramírez, “Fiscal Volatility Shocks and Economic Activity,” (Federal Reserve Bank of Philadelphia, Working Paper 11-32; August 9, 2011).
[4] Douglas Holtz-Eakin, “New $1.4 Trillion U.S. Stimulus is in Sight,” Bloomberg View (October 7, 2011); http://bloom.bg/qEJCrM
[5] An excellent review of past experience with repatriation, including a discussion of the potential stimulus effects, is found in Donald J. Marples and Jane G. Gravelle, “Tax Cuts on Repatriation Earnings as Economic Stimulus: An Economic Analysis”, The Congressional Research Service (May 27, 2011).
[6] See http://doggett.house.gov/images/pdf/jct_repatriation_score.pdf
[7] Some proposals would require that a significant portion of the repatriated funds be used to hire workers or buy equipment. In all likelihood this would either discourage companies from repatriation or claim the tax break against a hire they would have made anyway.
[8] We are skeptical of the claim that this provision of JTGA would create 50,000 jobs. Phil Verleger, a highly regarded industry expert with whom we consult regularly, estimates the impact on jobs would be between 0 and 1,000, with the most of those positions going to high-skilled people already in the industry, some of whom would be Canadian. At today’s prices, an eventual increase in production of 1 million barrels a day would, other things equal, raise the level of GDP by about 0.2%.
This is from a commentary that was published on October 20, 2011.
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