Testimony on House Resolution No. 42 – A resolution to memorialize the Congress of the United States to enact the President's tax cut proposals

The Mackinac Center for Public Policy is a nonpartisan research and educational organization devoted to improving the quality of life for all Michigan citizens by promoting sound solutions to state and local policy questions.

We believe that people respond to the incentives which are inevitably built in to public policy, both negative and positive. Common sense tells us that government tax policy has an effect on the willingness of entrepreneurs and investors to take risks and invest. History and empirical research backs up this common sense view, and confirms that these behavior changes have an effect on the general economy and the well being of citizens.

The Mackinac Center is a state-based institution, and as such has not performed an independent analysis on the president’s tax cut plan. I would like to share some of the findings of other organizations which have reviewed the proposal, and compare them to what our own econometric models show are the results of changes in Michigan tax policy.

The president’s tax cut proposal has three main components. Most economists believe the biggest economic “bang for the buck” comes from the proposal to exclude from individual taxable income stock dividends on which corporate taxes have already been paid. Economists have long argued that this double taxation of dividends reduces after-tax return on capital and discourages job-creating investments. It increases the cost of capital, and creates a “hurdle” which many potential enterprises cannot overcome. The result is that many potential jobs are never created. That’s why several nations - including Australia, France, Italy, Canada, Germany, Japan, and the United Kingdom - have abolished or reduced their double taxation of dividends.

The president’s proposal also accelerates the phase-in of the 2001 tax cuts. These include marriage penalty relief, expanding the 10 percent tax bracket, reducing marginal rates, and increasing the child tax credit. These tax cuts are currently scheduled to phase in over the next seven years.

Finally, the package would increase the maximum amount of investment in new equipment that could be immediately expensed by small businesses.

To measure the impact of these changes the Center for Data Analysis at The Heritage Foundation analyzed the president’s plan with a macroeconomic model developed by Nobel prize-winning economist Lawrence Klein and a team at the University of Pennsylvania.

The analysis shows that under the proposal, GDP would increase by an average of at least $69 billion through 2013. In 2004 and 2005 the amounts are $84 billion and $81 billion, respectively.

The projections show that the plan would add approximately 844,000 jobs each year through 2013. The 2004 and 2005 increases are 997,000 jobs and 1,036,000 jobs. Over the 10-year period, the increased job creation would cut the unemployment rate by one-half percent, on average.

Disposable personal income would increase by an average of $121 billion annually through 2013. The 2004 increase is $179 billion. For a family of four, annual disposable income is projected to increase by an average of $1,653 over the 10 years.

Roughly 73 percent of these effects are the result of eliminating the double taxation on dividends. The Center for Data Analysis has also broken down the job creation numbers by state. In Michigan, the model shows that some 36,000 new jobs would be created in 2004. The average number of new jobs created each year through 2008 would be 33,000.

The president’s proposal has also been analyzed with other models, including those of the Business Roundtable, Global Insight, and Macroeconomic Advisers. All these generally agree that it bolsters economic and employment growth in the early years. The Business Roundtable also concurs with Center for Data Analysis that the plan would create sustained long-term improvement in the economy. Both of these models consider demand and supply side factors.

The models which only found shorter term effects take into account mainly the demand side factors. Demand side models essentially look at the amount of extra money consumers have to spend after a tax cut, and measure increased economic activity likely to result from the new spending. Given that tax policy affects entrepreneurial and investor behavior, we believe that projections which take into account both demand and supply side factors are more accurate.

The Mackinac Center’s work in Michigan shows that changes in state tax policy have similar effects on the economy. We know that if you raise taxes, it costs jobs – and vice versa. State-level changes have a double whammy because of competition between the states for job providers. Not only do they impact the willingness of investors and entrepreneurs to put their money at risk, the wrong tax policies can drive these job creators to other states.

To help measure the effects, the Mackinac Center has acquired an econometric model which can estimate the impact of tax changes on Michigan's economy. This model, the State Tax Analysis Modeling Program, or STAMP, was built by the Beacon Hill Institute for Public Policy Research of Massachusetts. The program can determine the jobs and other impacts of tax increases or cuts on the Michigan economy, and separate the data into categories by income groups, industry sectors, and government revenue.

For example, we asked the model what would happen if, instead of dropping the income tax rate to 3.9 percent on Jan 1, 2004, as current statute requires, the cut was suspended and the rate remained at 4.0 percent. STAMP shows that such a move would cost the state 2,948 jobs in 2004. If the higher rate remains after one year then the negative effect on the economy continues to accumulate. There will be more job losses as we move forward. The industries with the greatest employment losses would be utilities, electronics, repair services, and business services.

Net investments here would fall by 0.2%, our exports would drop 0.5%, and private consumption would fall by 0.7%. Not surprisingly, the only areas to increase are government purchases (+0.11) and capital stock owned by government (+0.31).

The president’s proposal cuts the top marginal rate by 10 percent. We instructed the STAMP model to show the impact of a similar state income tax cut in 2004, from 4.0 to 3.6 percent. According to STAMP, such a move would create an additional 8,954 jobs in 2004 alone. While the model does not quantify job growth for succeeding years, we know that growth is cumulative, and, other things being equal, we would expect similar or larger figures moving forward.

In conclusion, the evidence we have seen, and our own experience and research, suggests that the president’s tax cut will have a net positive effect on the U.S. economy. The Mackinac Center also believes that the static “tax loss” models which ignore the supply side effects of the tax cut overstate the impact on federal tax receipts.

There has been a good deal of posturing in Washington regarding the effects of the tax cut on “the deficit” - much of it from notorious big spenders in both parties. In the 1980s, the strong economy created by the Reagan tax cuts actually increased federal tax revenue, but even faster spending growth created annual deficits. Sadly, congressional (and legislative) Republicans have shown themselves just as willing to spend. These bipartisan big spenders are the real source of deficit concerns – not a modest tax cut.

Since the puncturing of the Internet market “bubble,” and with the “wall of worry” erected by the 9/11 attacks, our economy has suffered from a lack of vigor. The economy only grows when entrepreneurs and investors are willing to put their capital to work. Their willingness drives growth and productivity gains, creates jobs, and makes us all better off. As President John F. Kennedy correctly observed, a rising tide does indeed lift all boats.

Overall, the president’s proposal is a modest step in the right direction. The elimination of double taxation on dividends will most likely boost stock market prices, boost 401(k) balances, and make it easier for entrepreneurs to raise the capital needed to finance economic growth. It is just the sort of “vitamin supplement” that a lethargic national economy needs. Similar tax cuts in Michigan would have similar effects. Plus, they would increase our ability to compete with other states.

Thank you for offering the Mackinac Center the opportunity to testify on this issue. I will try to answer any questions that members might have.

Jack McHugh is a legislative analyst for the Mackinac Center for Public Policy, and manager of MichiganVotes.org, a web-driven legislative database operated by the Mackinac Center.