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We're here with Kent Smeters. He's a
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Wharton professor of business economics
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and public policy. Welcome, Kent. Good
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to be here. He's going to talk to us
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today about the latest iteration of the
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Penn Wharton budget model which Kent was
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instrumental in developing and uh this
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is a free nonpartisan online interactive
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model uh which anyone can can plug into.
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Uh, and the last time we spoke, we
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covered social security and immigration,
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the effects that they might have on on
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the budget. And this time, we're going
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to talk about tax policy, uh, those
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policies of the two presidential
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candidates and also, I think, a couple
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of other, uh, leading proposals that are
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floating around Congress, but I guess
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we'll focus mostly on the presidential
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candidates. So, uh, let's just jump into
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it. What What are the different tax
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plans that you're analyzing? Yeah. So,
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we uh as you just mentioned the two
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presidential candidates Clinton and
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Trump and there's also been a very large
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effort by the House GOP led by Speaker
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Ryan and chairman Kevin Brady of the
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House Budget Committee. Um and so we've
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also been uh we also analyze their plan.
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So what are the main features of the
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plans for the average household? Yeah,
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for individual households there's all
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the plans have basically make two
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adjustments. The first is simply the
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marginal tax rates are changing. And in
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particular, the marginal tax rate is how
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much uh in taxes you pay for the next
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dollar that that you make. And
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economists generally believe marginal
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tax rates are much more important for
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economic activity than say the average
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tax rate that you you you face. And the
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second thing that the plans do is they
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change the amount of um itemized and
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standard deductions. And that's that's
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the amount of income that you can have
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before you're taxed. And what about for
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business taxation? That's where there's
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a lot bigger amount of changes,
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especially in the Trump and the House
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GOP plan. First, the corporate tax rate
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itself is lowered in both the Trump and
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the House GOP plan. And in the Clinton
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plan, it's actually increased uh a
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little bit. And the second thing that
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the Trump and uh uh House GOP plan in
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particular do, which is the the most
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aggressive thing, is that they
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accelerate the the rate at which uh uh
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companies can depreciate their capital
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investments. And economists actually
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generally believe that that's much more
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important for stimulating the economy
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than the corporate tax rate itself. And
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the reason why is by accelerating the
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amount of depreciation sometimes called
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expensing it only isolates new
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investment whereas changing the
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corporate tax rate is not just impacting
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new investment but existing installed
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capital as well. And uh the third thing
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that the Trump and uh Ryan plans do is
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that they affect what's called the pass
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through rate. Some capital income is
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taxed at the household level, some at
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the corporate level. More of theirs
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would be taxed at the corporate level,
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which will have a lower tax rate. So,
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what are the main differences between
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those plans? Right. I mean, it's a
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sweeping generalization. Um, but
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roughly speaking, you know, the Trump
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plan is the most aggressive. Uh, the
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Clinton plan is the least aggressive,
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and the House GOP is kind of in between.
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and um a bit a bit closer uh uh uh to
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the to the Trump plan. Though when you
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say aggressive, you mean just the the uh
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degree of change, just the overall
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degree of change. That's right. All
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right. So, um so users can go to your
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website and look at different scenarios.
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Uh the budget model for social security
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and immigration uh looked very much at
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uh uh specifically how an individual
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change would change the bottom line. But
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when it comes to taxes, it's a little
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more complicated because you get into
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behavioral issues. What will people do
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with a tax savings? How will they spend
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it? Where will they put that money? And
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as you talked about, for example,
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accelerated depreciation that's changing
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a company's business decisions. So talk
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about that a little bit, those
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differences. Yeah. So in the case of
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social security and immigration, what
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our simulas allow people to do is to uh
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go and play with their own policy ideas
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of for example um raising the retirement
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age or changing the amount of uh the the
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taxable maximum that's applied of income
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that's applied to social security. Um
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and the and less important in the in
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social security and immigration are
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things like demographic assumptions.
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Those are the things that economists are
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much more aligned on. Um, when it comes
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to tax policy, where the big
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disagreement is is is actually on the
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behavioral assumptions. And so that's
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what we're highlighting in the in the
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simulator itself. And also the
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candidates themselves, they have
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specified what the policies are. And so,
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um, we're focused more on, uh, giving
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letting people see if they believe, um,
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uh, one behavioral assumption is more
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important than the other. They can test
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their their their ideas. Eventually,
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after the election is over, we'll we'll
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bring back to the tax calculator, um,
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the ability for people to design their
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own tax plans. So, this difference u in
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in this behavioral aspect, how how is
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that handled? Because in the end, that's
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a judgment call. Correct. So you offer
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different scenarios where you can uh
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where where users could make a judgment
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about how they expect taxpayers to react
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and Yes. Yes. And so in particular
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there's really four basic um controls.
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The one that's the most important is the
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is the rate at which international
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capital will flow in and out of the
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United States. And that one is by far
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the most important um one because uh
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several of the tax plans in particular
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Trump and the House GOP will create some
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deficits along the way. And if
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international capital flows are very
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aggressive then that will um minimize
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the negative impact of those deficits on
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the economy. If uh however, if we're
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closer to a closed economy than those
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deficits that compete for household
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saving and reduce private capital um but
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then we have other assumptions. So
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that's that's the famous crowding out
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effect. Correct. Yes, that's that's
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exactly right. Okay. And so more
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international capital flows, less
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crowding out um and so it's more
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favorable. Um uh then we have other
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assumptions like how much do households
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themselves increase their labor supply
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or decrease it with respect to a tax
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change and uh this uh what's called a
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saving elasticity. How much do they
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respond in changing or saving?
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Historically academic models have really
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focused on those elasticities the labor
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supply elasticity and the saving
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elasticity. And the reason why is
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academic models typically focus on
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balanced budget um experiments uh kind
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of like optimal tax design type stuff
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for a given amount of revenue. But it
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actually turns out for this exercise um
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the international capital flows is by
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far the most important assumption. Uh
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and so how do these things stack up
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against each other? I assume I'm
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assuming that you made assumptions that
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your your best idea about how things
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were likely to go when you were choosing
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these behavioral aspects. Uh what did
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you find when you did that? Yeah, I mean
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so when we um we provide a a very
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generous uh range of those different
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behav behavioral assumption parameters
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and so it's not necessarily that I
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personally believe that range is that
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wide. You plural, but yeah, that's
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right. And uh but at the same time we do
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pick what we think is a reasonable
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baseline but then allow users to change
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that. And so when it comes to uh how do
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we come up with a reasonable baseline is
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that we've uh in conjunction of with uh
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building out the simulator have
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conducted empirical exercises and
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reviews of the literature to uh narrow
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down what we think is a reasonable kind
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of starting point for people. But in the
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case of the tax simulator, there's 256
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different combinations that people can
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play with, you know, so that they um if
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they have different judgments about it,
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they they can they can decide for
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themselves. But how did it turn out when
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you uh when uh your group let's say put
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in what would be the most likely
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scenario from their point of view,
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right? So we why don't we because the
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upcoming election maybe just discuss the
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the Clinton versus you know Trump
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analysis and so what we viewed as the
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most likely scenario
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um is uh for in the Clinton plan in the
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short run it's fairly neutral on the
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economy. There's a small little you know
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positive followed by a small little uh
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negative but it's it's it's fairly
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neutral in terms of uh GDP jobs and so
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forth. And this would be just tax
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policy, not accounting. For example, I
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mean, both candidates, for example, are
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talking about uh fiscal spending, right?
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They're talking about, you know,
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spending on infrastructure and that sort
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of thing. So, this is just looking this
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is isolating tax. That's right. It's
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it's focused on on just the tax policy
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in the long run because uh the Clinton
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plan is overall increasing taxes. it's
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actually leading to lower debt um that
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that otherwise would have occurred under
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current policy and that's actually
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having a positive effect on jobs. So by
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2027
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uh we're projecting there will be about
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600,000 more jobs by 2040 about 2
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million more jobs um uh than otherwise
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would have had in that year. So these
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aren't enormous changes, but they um
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start out at, you know, slightly neutral
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and then going to more more positive.
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For Trump, it's just basically the
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opposite. Almost all the bang comes
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early on. And in the in the short run,
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we're projecting that GDP will go up
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about 1.75%.
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And a real upperbound calculation on how
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many jobs would be calc uh would be uh
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produced um is about two two and a half
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million jobs would be produced early on
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with his approach. However, over time,
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because his plan is very unbalanced uh
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fiscally, it's going to produce fairly
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large deficits, and that's going to have
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this crowding out effect. It's going to
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be competing for with uh uh for with
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private capital for household saving.
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And so, we're projecting by within 10
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years, 2027,
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um he uh we'll actually have 700,000
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uh fewer jobs. And by 2040, if the debt
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is just continues to kind of almost
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spiral out of control, uh we're actually
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projecting 11 million fewer jobs.
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So it be very interesting down the road
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when policies are chosen and so forth
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for you to look back and say here's what
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the model projected, here's what
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actually happened and you'll be able to
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tweak it in and in in different ways.
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That's right. And and that's why I like
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to say all models are wrong. I mean
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there's no model that is going to have
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you know perfect crystal ball in into
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the future. What we really get from
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these models is more understanding kind
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of the direction of things. Is this
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likely to be stimulating or
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contractionary for that economy relative
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to where the economy eventually lands.
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Um it's those what we call deltas that
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we think are more reliable. And then
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essentially how big are those deltas?
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Are we talking about a small impact and
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potentially large large impact? And for
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someone who wants to dabble in this
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model, where can they go to see it?
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Yeah, they can go to um simply our our
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website wi which is uh uh www um
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budgetmodel.warton.upen.edu.
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Okay. Anything else you'd like to add
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that we haven't covered about this? No,
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I think um you know the big picture is
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this whole u um you know project is
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really consistent with you know the
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Wharton school's overall vision you know
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of trying to use data analytics
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advances in theoretical modeling as well
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as cloud computing all these things that
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we're we use um for things in you know
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like marketing and business analytics
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we're now applying this to public policy
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and so this is you know I think an
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exciting venture for us and and the
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Wharton School. Thanks for coming in
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today. Thanks for having me.
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[Music]
