November 15, 2010
Middle-income households that receive incomein the form of dividends or capital gains will seedirect tax increases if the Obama tax hikes pass.Even more troublesome, under the Obama taxincrease, investment spending would decrease,making economic recovery more difficult. Manyhouseholds, including lower-income households,would face a worsened job market, lower wages,and lower returns on their savings (investmentincome).
Dynamic Analysis: Obama TaxHikes Hurt Middle Class
When tax increases reduce economic growth orcreate incentives for taxpayers to evade taxes, theybring in less revenue than a static (purely accounting)projection would predict. The economy is a complexsystem where productive resources are used by mil-lions of people and turned into the goods and servicespeople need and want. In a market system, wherepeople specialize and trade, anything that affects theway people use resources and purchase goods andservices will have a system-wide effect. This happensas the direct effects of changing incentives cause peo-ple to make different allocation decisions. A chainreaction ensues that causes others to make differentbuying and selling decisions, which causes still othersto change their behavior and so on (whether they real-ize it directly or indirectly through higher prices ortighter budget constraints). When upper-income taxpayers have to payhigher taxes,
they often avoid some of their newtax burden by reducing investment income, whichleads to lower job creation. The chain reactionresults in fewer opportunities and smaller salariesfor lower-income workers.
Through lower wagesor decreased job duties, reduction in job creationaffects even those lower-income workers who arecurrently employed. While higher taxes affect everyone, not everyonethroughout the economy is affected evenly. Theuneven distributional changes can be analyzedusing the Center for Data Analysis IndividualIncome Tax Model and the IHS/Global Insight Mac-roeconomic Model. The dynamic effects on individ-ual income tax filers are estimated under differentpolicy scenarios: Current Policy (all tax cutsextended) and the Obama/Congressional Plan (taxcuts expire for upper-income filers).This is completed in three steps by first modelingthe tax policies using the traditional static (micro-economic) method, obtaining dynamic macroeco-nomic results from a simulation of the policy usinga structural model of the U.S. economy, and thentranslating the dynamic forecasts of the macroecon-omy under the different policies back to the micro-simulation model in order to estimate what microchanges most likely led to the macro effects. Forexample, Obama’s proposal results in lower dispos-able income relative to a current policy (full exten-sion) baseline. A lower aggregate means individualsin the economy have lower disposable income. Bychanging the microsimulation model’s baseline tar-get for aggregate disposable income to the ObamaPlan target, the model can show how individual fil-ers’ incomes will change.
The dynamic microsimulation gives a moreaccurate picture of the effect of the proposal thathouseholds in the different income quintiles willexperience. A static analysis, which only estimatesdirect changes in tax burden, misses the indirecteconomic effects. Statically, a household filing jointly with no dependents earning an adjustedgross income (AGI) of about $130,000 in 2014 hasan average tax increase of $1,440. But when thedynamic effects due to lower productivity are takeninto account, wages and other income shows thereal income loss to be $2,700 for this filer. In other
1.For a more detailed analysis see William W. Beach, Rea S. Hederman, Jr., John L. Ligon, Guinevere Nell, and Karen A. Campbell, “Obama Tax Hikes: The Economic and Fiscal Effects,” Heritage Foundation
Center for Data Analysis Report
No. CDA10-07, September 20, 2010, at
.2.Total employment would decrease by an average of 693,000 jobs over the 2011 to 2020 forecast horizon. Annual joblosses would peak at 876,000 in 2016, reducing wage and salary income for households in every income category.3.See the Methodology in the appendix for full details.