A new study of the economic impact of the Treasury Department's tax-simplification plan has found that it would make the economy run far more efficiently than would another simplification plan sponsored by congressional Democrats.
The study, released yesterday by John H. Makin, Don Fullerton and Michael T. Allison of the American Enterprise Institute, is the first to try to measure how tax simplification would affect the efficiency of the economy. Rather than focusing on overall growth, as past studies have done, this one looks at which tax plan would provide the most efficient return.
It found that the proposal sponsored by Sen. Bill Bradley (D-N.J.) and Rep. Richard Gephardt (D-Mo.) would result in almost no gains. The Treasury plan, which President Reagan has not endorsed, does better, but also falls short of a third alternative: a pure consumption tax, which exempts all savings, would lead to gains four times greater than those under the Treasury plan.
Another plan, sponsored by Rep. Jack Kemp (R-N.Y.) and Sen. Bob Kasten (R-Wis.), was not studied.
"The reason for the gap between the Treasury plan and Bradley-Gephardt is the enhanced amount of savings under the Treasury proposal," Makin said. "Both increase labor supply, and Treasury increases it more. Treasury has a positive effect on saving and Bradley-Gephardt has a negative effect on saving."
Both proposals would lower personal and corporate income-tax rates while eliminating many deductions and credits. Unlike Bradley-Gephardt, the Treasury plan tries to account for the effects of inflation by indexing the value of various assets and interests, and that explains its greater incentive to save, Makin said.
The AEI results tend to be more theoretically oriented than those of the large forecasting firms that have analyzed the Treasury plan.
Wharton Econometrics and Data Resources Inc. have both predicted that enactment of the Treasury proposal would increase personal spending and depress business investment to the overall detriment of economic growth in the early years.
"Those are both demand-side-dominated, macro-type models," Makin said. They predict some of the large-scale changes tax simplification could bring about, but don't focus on the myriad of relationships that would be altered, or how much better off the economy would be if investment were allocated by the market rather than influenced by the tax code, he said.
Fullerton explained the notion of efficiency gains with an analogy. If there were enough tax incentives, companies could be induced to convert all their production to, say, ping-pong balls. But, said Fullerton, "that wouldn't be the right stuff." Consumers and companies would lose because there would be too many ping-pong balls and not enough of the things they wanted. The extent to which the economy would be better off if the right stuff were produced is the efficiency gain.
If the Treasury plan had been in place all along, the improved efficiency would make real gross national product $413 billion higher than the roughly $1.7 trillion it is now, according to the study. Under Bradley-Gephardt, it would be $8.4 billion higher. And under the pure consumption tax, it would be $1.2 trillion higher.
A Treasury spokesman said the department would not comment because officials had not seen the study.
Jesse Abraham, an economist with DRI, said his firm had indeed taken efficiency changes into account, but concluded that they would not be very large for a long time because the reallocation of capital would take years.