July 17, 2008
CBO sent a letter today to Senator Conrad estimating the long-term fiscal effect of two personal income tax proposals. The first would index the Alternative Minimum Tax (AMT) for inflation beginning in 2008. The second would, in addition to indexing the AMT for inflation, also permanently extend the personal income tax provisions of the Economic Growth and Tax Relief and Reconciliation Act of 2001 (EGTRRA) and Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) that otherwise would expire in 2010.
Budgetary impacts
- Compared with the extended-baseline scenario in our long-term budget scenario, indexing the AMT, by itself, would reduce revenues by 2.5 percent of GDP in 2050 and by 2.6 percent in 2082. If those revenue losses were not offset by other changes in policy, the budget deficit would grow to 10 percent of GDP in 2050 and 30 percent of GDP in 2082 (relative to 5 percent and 18 percent, respectively, under the extended baseline scenario).
- Extending EGTRRA and JGTRRA in addition to indexing the AMT would reduce revenues by about 4 percent of GDP in both 2050 2082. If not offset by other changes in policy, this would result in budget deficits of 15 percent of GDP in 2050 and 39 percent in 2082. Under these policies, federal debt held by the public would increase to 190 percent of GDP in 2050 and to more than 600 percent in 2082 (relative to 50 peercent and 240 percent, respectively, under the extended baseline scenario).
Economic effects
- To assess the economic effects, CBO compared a scenario with the tax changes financed through deficits with an alternative scenario in which the tax changes were financed fully from the start via changes in other policies. Because the analysis assumes that the tax changes are enacted in either case, the difference between the two scenarios highlights the effects of using deficits to finance them.
- For example, simulations using one modela textbook growth model that incorporates the assumption that deficits affect capital investment in the future as they have in the pastindicate that the rising federal budget deficits created by deficit financing of the indexation of the AMT would reduce real GNP per person by 6 percent in 2050 and by about 37 percent in 2080. If both the AMT were indexed and EGTRRAs and JGTRRAs personal income tax provisions were extended, and those changes were financed by additional borrowing, the economic costs would be even larger. By CBOs estimates, real GNP per person would decline by 13 percent in 2050. Beyond 2073, projected deficits under those tax policies would become so large and unsustainable that the model cannot calculate their effects.
- Despite the substantial economic costs generated by deficits in that model, such estimates may significantly understate the potential loss to economic growth under deficit financing of the tax changes. In particular, the estimates are based on a model in which people do not anticipate future changes in debt; as a result, the model predicts a gradual change in the economy as federal debt rises. In reality, the economic effects of rapidly growing debt would probably be much more disorderly and could occur well before the time frame indicated in the scenario. Simulations using CBO's other economic models (which are more responsive to changes in tax rates than CBO's textbook growth model) also show that the outcomes could be worse than the textbook growth model indicates.