Republicans Twist Flawed Study To Claim Higher Taxes On Wealthy Would Harm Economy

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July 19, 2012 8:47 am
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Republicans are citing a new report (PDF) by economists at the accounting firm Ernst & Young to claim that President Obama’s plan to allow Bush tax cuts benefitting high-income earners to expire could have serious macroeconomic consequences, including 710,000 job losses.

Major business trade associations, including the Republican friendly Chamber of Commerce and the National Federation of Independent Businesses, commissioned the analysis. And according to independent economists, there’s reason to be skeptical of its assumptions, and of the way the findings are being portrayed in the political realm.“Seems odd that the researchers didn’t consider the scenario in which the additional tax revenues are used for deficit reduction,” said Moody’s chief economist Mark Zandi. “It seems to me that is the more relevant scenario. And my sense is that if they did, the results would be very different.”

Indeed, the Ernst & Young study forecasts based on two different assumptions: That the higher revenues are either used to finance across the board tax cuts, or to finance new government spending. It’s only in the latter scenario that the analysts forecast significant economic contraction.

“It is telling that when the additional tax revenues are used for across the board tax cuts, then the negative GDP impact is largely washed out and the employment impact is positive,” Zandi says.

The authors of the report did not respond to a request for comment Thursday morning.

Dean Baker, co-founder of the liberal Center for Economic and Policy Research offered a similar observation. “It calculated the impact of a tax increase that is used for higher government consumption spending. It does not measure the impact of a tax increase that is used either for deficit reduction or investment in infrastructure and education,” Baker wrote. “The model used in this analysis would likely to show that either of these two uses of higher tax revenue would lead to increases in output, jobs, and wages, not decreases.”

In a followup email, Baker also noted that one of the report’s key assumptions is ahistorical.

“The [projected] reduction in output is due to the fact that with a lower real wage people will opt to work less — thereby less output,” Baker writes. “The empirical support for effects of the size described in the study is pretty weak. If we get this big a loss with tax rates at 39.6 percent, imagine the hit when we had tax rate at 70 percent or even 90 percent. Working backward from the projections in the study, we could say that annual growth would have been 1-2 percentages points higher in the 50s, 60s, and 70s, if we had the current tax rates. I doubt anyone believes that.”

But the reports also being interpreted as if it concludes that the shock to the economy would be immediate. That’s false.

“The projections discussed in the article are long-run projections, not effects that would be felt in the next year or two,” Baker writes.

And then there’s a timing issue. The report was released earlier this week, before Senate Democrats had unveiled the legislative details of their plan to extend the Bush tax cuts for everyone’s first $250,000 of income. The report assumes that Democrats propose to increase the tax on dividends for those with income above $250,000 to 39.6 percent. In reality, the Democrats’ proposal is much more modest.

According to an official summary of the plan, “For income in excess of $200,000 (individual filers), $225,000 (heads of households) and $250,000 (married filing jointly), the rate for both capital gains and dividends will be 20%.”

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