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271 IRET Congressional Advisory 1 (2010)

handle is hein.taxfoundation/iretcgadv0268 and id is 1 raw text is: INSTITUTE FOR RESEARCH ON THE ECONOMICS OF TAXATION IRET is a non-profit 501 (c)(3) economic policy research and educational organization devoted to informing the public about policies that will promote growth and efficient operation of the market economy. December 8, 2010 Advisory No. 271 THE TAX COMPROMISE The Congressional leadership and President Obama have agreed on a tax compromise. It would: 0 Extend the Bush income tax cuts for two years, including the tax rate reductions in the top brackets affecting upper income taxpayers, and various tax credits that are part of the Bush tax cuts, including increases in the Earned Income Credit (EIC), child credits, and education credits; 0 Reimpose an estate tax at 35% top rate with a $5 million exempt amount for two years (restoring the tax at the levels in effect in 2009, after it had lapsed entirely for 2010); 0 Reduce the employee share of the retirement portion of the payroll tax by two percentage points for 2011 (from 6.2% to 4.2%); 0 Increase the temporary 50% expensing provision to 100% for 2011 for some investments, followed by a return to 50% for 2012. 0 Enact a number of extenders including a two year alternative minimum tax (AMT) patch and renewal of the R&E tax credit. 0 Extend long term unemployment benefits through 2011. It is incorrect to analyze the economic effects of the tax changes by looking at how much money they leave people to spend. The government will have to increase its borrowing by a similar amount, offsetting any immediate demand effects of the tax relief. Instead, one should look at the incentive effects of the tax changes - how much more people get from working an extra hour or saving and investing an extra dollar. That is what determines the quantities of labor and capital available for producing output and income. We employ a neoclassical model combined with a tax calculator that responds to changing income levels to calculate the dynamic GDP and income effects of tax policy changes.1 Without the extension of the income tax cuts, we estimate that the GDP and individual incomes would slip over time by 7.1 percent, compared to levels achievable under retention of the tax cuts. Note that extending the Bush tax cuts is not a reduction in tax rates from current levels. It is the prevention of an increase. Without the extension, production incentives would fall sharply, eventually trimming about seven percent off the long run path of GDP. We need the extension of the Bush cuts (along with the AMT patch and R&E credit) just to keep things from getting worse. Even the threat of the tax increases has held back investment and hiring in recent months. To the extent the threat has been removed, there will be some improvement in economic production and incomes from current levels. The extensions will mean a big improvement compared to what would occur without them. The marginal tax rate extensions - particularly keeping the maximum tax rates on dividends and long term capital gains at 15% - are the main source of economic incentives in this package. The biggest effect is to prevent what would otherwise be a significant reduction in saving and investment had etmsm I, S I gg~ g Agg

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