Despite its massive spending cuts, House Budget Committee Chairman Paul Ryan’s budget (which the House is considering this week) would still have a deficit of $287 billion in fiscal year 2022. And the Congressional Budget Office estimates that it wouldn’t produce a surplus until 2040.
Chairman Ryan disagrees, saying in a report that if you factor in the great boost that his tax proposals would give to the economy, his plan could balance the budget by the end of this decade. But his case is unconvincing.
The Ryan plan proposes to replace the current individual income tax system with two brackets — 10 percent and 25 percent — for ordinary income and no alternative minimum tax, with a top corporate rate of 25 percent. These changes would reduce revenues by $4.6 trillion over ten years (compared to the revenue levels if Congress extended all of President Bush’s 2001 and 2003 tax cuts, including those benefitting only upper-income taxpayers), according to the Urban Institute-Brookings Institution Tax Policy Center. Chairman Ryan says his plan will fully offset that revenue loss by cutting tax expenditures (credits, deductions, and other preferences), but he hasn’t provided any details.
Chairman Ryan’s report assumes that his tax reform, if enacted in 2013, would boost economic growth by as much as one percentage point a year for a decade starting in 2015; by 2019, that would produce enough extra revenues to balance the budget. It cites a review of the literature on the economic effects of tax reform by economists Alan Auerbach and Kevin Hassett. But what Auerbach and Hassett wrote — that “the literature suggests that a wholesale switch to an ideal [tax] system might eventually increase economic output by between 5 and 10 percent, or perhaps a slightly wider range” — doesn’t support Chairman Ryan’s claim for several reasons.
First, and most importantly, the Ryan tax proposals would fall far short of the fundamental tax reform that Auerbach and Hassett were discussing, which would effectively replace the current income tax with a national consumption tax. Such reform plans would eliminate all tax expenditures, including tax breaks for such things as homeownership, charitable contributions, and employer-provided health insurance. That the Ryan plan fails to specify any tax expenditures for cuts is just one sign of the political difficulty of substantially reducing them, much less eliminating them.
As economist William Gale notes in the Auerbach-Hassett book cited above, the type of tax reform economists are discussing would “cause significant relocation in the economy, and declines in charitable contributions, real housing prices and the number of households with health insurance.” Furthermore, such a pure tax reform plan would be far more regressive than the current system, with lower- and middle-income taxpayers paying more and people at the top getting even bigger tax cuts than they would get from extending the expiring Bush tax cuts. Mitigating these effects would require higher tax rates, which would reduce or eliminate the longer-term economic benefits of tax reform.
As Gale concludes, when tax reform is “subjected to the realistic considerations noted above and the higher tax rates such considerations would require, studies suggest that the [new tax system] would likely generate little if any net growth and could actually reduce growth.”
Second, Auerbach and Hassett’s conclusion that “a wholesale switch to an ideal system might eventually increase economic output by between 5 and 10 percent” (emphasis added) is far from Chairman Ryan’s claim that if Congress enacts tax reform in 2013, output will likely be 5 percent higher by 2019, as the Ryan report apparently assumes.
Third, as Auerbach and Hassett point out, the consensus in the economic literature about the possible effects of fundamental tax reform “may exist because all the models employed by economists have relied upon some simplifying assumption that will eventually be found inappropriate. That is, it might well be that the models will be poor predictors of experience.”
The bottom line is this: the tax reform reflected in the Ryan plan will not likely boost the economy significantly. Even if policymakers enact and sustain the Ryan plan’s massive spending cuts, the budget probably wouldn’t be balanced much before 2040.