As President Donald Trump’s administration releases its proposed tax plan, economists at the University of Pennsylvania’s Wharton School — where Trump obtained his undergraduate degree — offer a prognosis of its impact on the economy, should it pass Congress in its current form: a quick boost, and then a long, and long-term, slowdown.
According to the Penn Wharton Budget Model (PWMB), a nonpartisan research organization within Wharton, Trump’s newly unveiled tax plan would reduce economic growth compared to the current tax structure, in large part because it would increase “federal debt relative to current policy.”
“In the short run, the results on the Trump plan are getting a boost out of all these tax cuts,” Kimberly Burham, managing director of legislation and special projects at PWMB, tells Poets&Quants. “But in the long run, because the tax cuts increase the debt, that drags down economic growth. And, in fact, in the very long run it’s even negative (as well).”
Summarized to reporters today (April 26) by White House Chief Economic Adviser Gary Cohn and Treasury Secretary Steven Mnuchin, the tax plan, which does not stray far from Trump’s 2016 campaign rhetoric, would slash corporate tax rates from 35% to 15%, shrink to three from seven the number of income brackets, and eliminate federal tax deductions besides charitable giving and mortgage interest. Wharton’s tax policy simulator was actually created last summer to evaluate the impact of proposed tax plans from Trump, Democratic candidate Hillary Clinton, and the House GOP on the country’s economic growth; since the plan released today is essentially a copy-and-paste job from a campaign one-pager, Burham says the Wharton models still accurately indicate where the country’s economic strength could be headed.
There are some differences, Burham says, and those are incorporated into the tax policy simulator. “The differences are the standard deduction in the simulator is a little bit higher than what the White House came out with today — $30,000 instead of about $24,000,” she says. “The top individual bracket that he proposed on the campaign trail was 33%, and today he proposed 35%. And one of the other key differences is, on the campaign trail he proposed to cap itemized deductions at $100,000 for singles and $200,000 for married. Today he proposed to eliminate everything except mortgage interest, retirement, and charitable giving.”
SIMULATOR BASED ON ‘HUNDREDS OF THOUSANDS’ OF DATA POINTS
The tax policy simulator is one of three policy simulators the PWBM runs. Burham says it has “static” and “dynamic” versions; the static or statistic simulation is based entirely on census data on “hundreds of thousands” of U.S. citizens.
“We have all kinds of information about them,” Burham says. “We simulate their lives going forward — having kids, going to school, getting married, retiring, paying taxes, how they work — and it’s that model that we integrated with the Tax Policy Center’s Static Microsimulation Model for the tax analysis.”
The dynamic model includes how tax policy changes actually influence future economic growth.
“Households make decisions and choices about how much to work and save given wages and interest rates,” Burham explains. “And if there is a policy that changes wages or interest rates in the future, then households will change how they work and save in this model. And that way, they might change what GDP is in the future or what tax revenues are in the future. We want to produce a real fact-based result based on data.”
TRUMP’S PLAN: LIKELY LONG-TERM ECONOMIC SLOWDOWN
The tax simulator shows predictions on Trump’s plan versus a baseline of the current policy, proposed House GOP policy, and Clinton’s proposed policy in gross domestic product, the federal deficit and surplus, debt held by the public, and other categories. It gives a baseline rate for potential influences on those categories, like rate of foreign investment in U.S. companies, savings and labor supply elasticity, and federal policy changes excluding Social Security and Medicare. Users can change rates in those categories to examine different scenarios.
The idea, Burham explains, is to get people talking about “appropriate assumptions” rather than basic policies or ideologies.
“We don’t promote another side and we are nonpartisan, so we focus on the numbers and what they are telling us,” she insists. Across the board, those numbers point to one conclusion: short-term gains and long-term slowdowns in both the Trump and House GOP plans, and a short-term slowdown but long-term gains under Clinton’s proposed plan.
TRUMP’S PLAN: LIKELY HIGHER PUBLIC DEBT
“The reason why Clinton’s plan fares a little bit better is because she is not changing the debt as much,” says Burham, referencing the predicted “debt held by the public,” currently estimated to be about $13.275 billion. Clinton’s proposed plan actually would have increased that debt by a lesser amount than the current policy, under which the public debt will balloon to an estimated $39.92 billion by 2040. Trump’s plan would explode that debt to $56.931 billion.
“Clinton’s tax plan is actually reducing debt held by the public, while Trump’s plan is increasing debt held by the public,” explains Burham, noting that the main cause is Trump’s proposed tax reductions. “But maybe he can make up for that in terms of revenue by changing spending,” Burham continues. “He could also make up for that by tax policies that generate revenue. But as his tax plan was then, it was decreasing government revenue without making up for it.”
The public debt, she adds, “is a drag on the economy, because it changes interest rates and return to work in the long-term.”
COLUMBIA: CORPORATE TAX CUTS LEAD TO GROWTH, ULTIMATELY
Of course, there are at least a few limitations to the model. The biggest, Burham says, is trying to predict interest rates decades in the future. There are also many potential unpredictable influences on the model, like recessions or war. Another predictable influence is the fact Trump won’t be in office forever.
According to another study published earlier this year by researchers from Columbia Business School and Duke’s Fuqua School of Business, corporate tax cuts should ultimately lead to economic growth.
“Our findings show that because of the relatively higher corporate tax rates in the U.S., fewer profits of American firms are being channeled into domestic investments, which leads to a lower economic growth rate,” Urooj Khan, Columbia Business School professor and co-researcher on the study, said in a news release from the school last month.
‘DEBATE FOCUSED MORE ON FACTS AND DATA’
Wharton’s models do show a quick surge in economic growth, Burham says. “But without accounting for revenue lost from tax deductions, the models predict an eventual hole and economic shrinkage.
“Our model indicates that plans without a lot of foreign investment and tax plans that increase the debt are not going to be good for growth in the long run,” she says.
Either way, Burham and team have one mission to maintain moving forward. “We’re hoping by introducing models like this that we can get the debate focused more on facts and data.”