Statement of Allen Sinai, Chief Global Economist, Center for Policy Research,
American Council for Capital Formation, and President, Decision Economics, Inc.

Testimony Before the House Committee on Ways and Means

Hearing on President's Tax Relief Proposals that Affect Individuals

March 21, 2001

Special Report -- March 2001

Macroeconomic and Revenue Effects of the Elimination of the Estate Tax

For nearly a quarter of a century, the ACCF Center for Policy Research has sponsored pathbreaking research on tax policies to encourage saving, investment, and economic growth. As the Bush Administration and the U.S. Congress prepare to debate various tax reduction proposals, the Center, in order to focus the discussion on the macroeconomic impact of five different options for repealing or reforming the federal estate tax, offers this Special Report, based on macroeconomic estimates, prepared by Dr. Allen Sinai, chief global economist and president, Decision Economics, Inc.

The key conclusions of Dr. Sinai's preliminary findings are that when his model of the U.S. economy is used, estate tax repeal or reform increases both real Gross Domestic Product (GDP) and U.S. employment, compared to the baseline forecast. In addition, there are more new business incorporations and greater potential output of goods and services. Finally, federal tax receipts rise in response to the stronger economy, feeding back approximately $0.20 per dollar of estate tax reduction, to some extent helping to pay for the estate tax reduction. In fact, one of the options, immediate repeal and elimination of step-up in basis, could increase total federal net tax revenues by $55 billion over the 2001-2008 period due primarily to the repeal of step-up in basis. ACCF Chief Economist Dr. Margo Thorning was invited to testify on the ACCF/Sinai study's findings before the House Ways and Means Committee on March 21. Earlier, the study was released at a March 15 Senate Finance Subcommittee on Taxation hearing on death tax repeal and reform.

Introduction

The Sinai-Boston Econometric Model of the U.S. is a large-scale quarterly econometric model that includes considerable detail on aggregate demand, financial markets, sectoral flows of funds and balance sheets, interactions of the financial system with the real economy, and detailed trade and international financial flows. The advantage of a general equilibrium macroeconomic model instead of a partial equilibrium model for analyzing the impact of a change in the tax code is that a general model measures how the economy will respond after all aspects of the economy, financial system, inflation, and potential output are allowed to adjust to the new tax rates.

Macroeconomic Impacts

Dr. Sinai estimates the impact of five different reform and repeal options, including: 1) immediate repeal coupled with elimination of the step-up in basis; 2) immediate repeal of the estate tax with step-up in basis retained; 3) phaseout of the estate tax over eight years; 4) reduction of the top estate tax rate from 55 percent to 20 percent (the highest capital gains tax rate); and 5) reduction in the top estate tax rate from 55 percent to 39.6 percent (the top current individual income tax rate). Option 3 passed Congress last year as H.R. 8, the "Death Tax Elimination Act of 2000."

Preliminary results from early simulations, subject to further work and analyses, suggest the following effects from immediate elimination or reform of the estate tax, retroactive to January 1, 2001.

• GDP increases a cumulative $90 billion to $150 billion over the 2001-2008 period, or 0.1 percent to 0.2 percent compared with the baseline for several years out of the eight years in the preliminary runs (see Figure 1 and Table 1).

• Job growth ranges from 80,000 to 165,000 per year and the unemployment rate is slightly lower as a result (by 0.1 percent), with essentially no change in the inflation rate (see Figure 2 and Table 1).

• Both consumption and personal saving rise, as does national saving, despite the loss in estate tax receipts to the federal government.

• The level of potential output is somewhat higher, by an average $6 billion to $9 billion per year.

• Tax receipts, excluding estate tax receipts, rise in response to the stronger economy and financial system, feeding back approximately $0.20 per dollar of estate tax reduction, to some extent helping to pay for the estate tax reduction. One option--immediate repeal combined with the elimination of step-up in basis--increases total federal tax receipts by almost $55 billion over the 2001-2008 period compared to the baseline forecast because of the tax saving from elimination of step-up and the increase in capital gains realizations (see Figure 3 and Table 1).

Dr. Sinai estimates that about $45 billion of the $55 billion revenue increase is due to the elimination of step-up, rather than to faster economic growth.

Phasing in estate tax relief over eight or 10 years obviously reduces the macroeconomic impacts as does eliminating step-up in basis.

Conclusions

While work remains to be done in simulating and estimating the effects of removing the estate tax, this early work provides a glimpse of the directions of movement for key parameters of the macroeconomy--economic growth, jobs, entrepreneurship, and potential output--in response to estate tax elimination. Dr. Sinai's findings about the positive economic impact of estate tax repeal buttress the results of a recently released ACCF Center for Policy Research analysis by Syracuse University Professor Douglas Holtz-Eakin, "Estate Taxes, Labor Supply, and Economic Efficiency."

Allen Sinai is President and Chief Global Economist of Decision Economics. PDE is a global economic and financial market information and advisory firm serving financial institutions, corporations, governments, and individual investors, with offices in New York, Boston, London, and Tokyo. Dr. Sinai is a pioneer in econometric model building and the information systems approach to economic forecasting, analysis, and monitoring. His previous experience includes senior-level positions at Lehman Brothers, Inc., and Data Resources, Inc. (where he was a co-developer of the DRI model of the U.S. economy). He also has participated in finance and economic programs at several prominent universities, is a fellow and past president of Eastern Economic Association, and author of numerous articles and publications. His advice is sought by both political parties, Congressional committees, and he has served as a consultant to the Federal Reserve Board. Dr. Sinai holds a B.S. degree in economics from the University of Michigan and Ph.D. in economics from Northwestern University.

Table 1: Impact of Estate Tax Repeal/Reform on U.S. Economic Growth, 2001-2008
Changes from baseline, cumulative except as otherwise noted

Note: Assumes the saving in taxes paid is treated as an increase in disposable income as opposed to reinvesting in assets or paying down debt. Under different assumptions about how the tax savings is taken, the quantitative .estimates might change but the direction of the results would not.

Source: "Macroeconomic Effects of the Elimination of the Estate Tax," by Allen Sinai, chief global economist and president, Decision Economics, Inc., preliminary report prepared for the American Council for Capital Formation Center for Policy Research, Washington, D.C., March, 2001.