Jobs, Productivity, and Jeb Bush’s Tax Plan

As a matter of accounting, there are two way to increase U.S. economic growth and thereby boost incomes of Americans: increase productivity and increase jobs.  As economists put it, the rate of economic growth equals the rate of productivity growth plus the rate of employment growth.  So if you want to evaluate whether a candidate’s tax reform—or any other economic policy reform—increases growth, ask whether—and how—it boosts productivity and jobs.

Jeb Bush has now put out the most detailed comprehensive tax reform plan of the 2016 presidential campaign.  (See the Tax Foundation’s list and comparison of current tax plans of candidates.)  His tax plan bodes well for future economic growth because it addresses, in many ways, both the jobs and the productivity problems. And these problems are severe: The employment-to- population ratio has not increased over that of the bottom of the recession, and productivity growth is less than half its historical norm.

First consider jobs.  Most significantly, the reform reduces income tax rates across the income distribution to 10%, 25%, and 28%, thereby lowering a key distortion that discourages employment, and it goes further by eliminating the marginal tax rate induced by the complex phase-outs of the personal exemption and the limit on itemized deductions. The reform also eliminates the employee portion of the Social Security payroll tax for people over the full retirement age;  this part of the reform is based on a proposal by John Shoven and George Shultz, and it reduces a distortion that discourages older people from remaining in the labor force. Jeb Bush’s reform also reduces the marginal tax rate for married couples who both work by allowing the individual with the lower wage and salary income to file a separate tax return using the tax schedule for single filers. By increasing the standard deduction to $11,300 for single filers and to $22,600 for joint filers, the reform lowers marginal tax rates and simplifies the tax code. And by extending the earned income tax credit beyond families with children, the reform further expands the cut in marginal tax rates on earnings from work to as little as zero.

Next consider productivity. The reform substantially reduces business tax rates: The federal corporate income tax rate is cut from 35% to 20% and the top personal income rate–cut from 39.6% to 28%–applies to many small businesses.  These business tax cuts would raise the expected profitability, and thus the incentive, for a firm to expand and invest in new facilities and equipment which directly increases labor productivity.  Because new technologies are embodied in this new investment, productivity increases further due to information, telecommunication and other innovations.  Importantly, the reform also allows businesses to expense their capital investments—rather than deduct scheduled depreciation over time—which creates another large incentive for businesses to expand and invest in capital, further boosting labor productivity.  The reform would move the US corporate tax to a territorial tax system (with a deemed repatriation tax of 8.75% during the transition) which would also increase capital investment and thus productivity. And the reform reduces the risk-inducing tax distortion between debt and equity financing of these investments by eliminating the deduction of interest on loans.

The plan is classic tax reform in the sense that the above tax rate reductions and others are accompanied by significant base-broadening.  The base-broadening proposal is remarkably specific and transparent compared to many tax reform proposals of the past. It comes largely from the elimination of the deduction for state and local taxes and a cap on the tax value of deductions other than charitable contributions at 2 percent of adjusted gross income. That the cap is on the tax value of deductions rather than on actual deductions effectively means that upper-income taxpayers get a smaller deduction as a share of their income than middle- or lower-income taxpayers.

When scored statically the tax rate reduction combined with the base broadening reduces taxes by $376 billion, or by 1.37 % of GDP, in the year 2025, and by roughly similar amounts in the preceding ten years. But for the reasons stated above the plan would increase economic growth, and even a modest increase in growth creates substantial tax revenue feedback. The Tax Foundation estimates about 60% feedback, which means that the reduction in tax revenue would be about $150 billion in 2025.

And the plan fits nicely into the current budget outlook with sensible restraint on the growth of outlays.  The CBO’s forecast for baseline revenues in 2025 is 18.3 percent of GDP. Without any feedback—again an unrealistic assumption—the reform would take this to 16.9% as a share of GDP. That is actually very close to the 17.6% federal outlay share of GDP in 2000 and 2001 at the end of the Clinton Administration.  It is also close to the 18.1% of GDP in 2025 called for in the 2016 Budget Resolution involving a gradual reduction in the outlay share compared to the CBO baseline, which I have testified would itself would be good for economic growth. So combined with sensible spending restraint comparable to that in the current budget resolution, the tax reform fits very well, and this is without giving any credit to the increase in economic growth which the plan is all about.

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