04.02.24

Penn Wharton Hearing Witness: Dem Tax Proposals Won’t Solve Our Fiscal Challenges

Grassley releases expert’s responses to his follow-up questions for the record.

BUTLER COUNTY, IOWA – Senate Budget Committee Ranking Member Chuck Grassley (R-Iowa) today released responses Dr. Joao Gomes submitted for the record after serving as a minority witness at a hearing titled “Recreation at Risk: The Nature of Climate Costs.” Gomes is a senior vice dean at the University of Pennsylvania Wharton School, which administers the widely respected, nonpartisan Penn Wharton Budget Model.

“Dr. Gomes’ answers to my questions offer a blunt analysis of our nation’s economic trajectory. The Budget Committee owes it to the American taxpayer to give his responses a thorough read and invite more experts like him,” Grassley said. “The Budget Committee has held 15 hearings on climate this Congress – that’s 15 missed opportunities to work on the budget. My Democratic colleagues have yet to act on my calls for fiscal responsibility while the debt burden grows; perhaps they’ll take Dr. Gomes’ expertise to heart and finally shift focus.” 

Read Gomes’ full responses HERE. A question-by-question overview and excerpts follow. 

QUESTION 1:

Grassley: Your testimony was a stern warning of the dangers of our current fiscal trajectory. What warning signs should this committee heed?

Gomes: […] Real interest rates – and hence the cost of funding the US Federal debt - are going to be much higher in the coming decade or so. Thus, if there is one single indicator to watch for over the coming years, is the evolution in the real cost of funding the U.S. Federal debt.

QUESTION 2:

Grassley: Democrats commonly claim that tax increases on the rich will be enough to right our fiscal ship. Is “taxing the rich” a feasible solution to our monumental fiscal challenges?

Gomes: […] Even an expansive version of President Biden’s recent tax proposal, that, among other things, lets the temporary provisions of the 2017 Tax Cuts and Jobs Act expire in 2025, increases the top marginal tax rate to 45%, and adds a new AMT rate of 45% above $1 million, would still fail to prevent the federal debt held by the public from continuing to grow steadily and reach 150% of GDP by 2050. That is not enough to remove the existential threat that our precarious fiscal position poses to the U.S. economy. 

QUESTION 3:

Grassley: Chairman Whitehouse indicated his support for a carbon tax during the hearing. He claims that his carbon tax would generate $2 trillion in savings. Who would end up paying the price tag for his Save Our Future Act? Are there any other pitfalls of his carbon consumption tax?

Gomes: I have not seen any estimates of the impact of these types of taxes in the context of detailed dynamic macroeconomic models (such as those used by the CBO and PWBM) that plausibly account for the equilibrium impact of such large tax changes on the overall economy.

[…] Nevertheless, I am inclined to agree with Senator Whitehouse that a carbon tax system could probably raise significant tax revenues, in the near term. It is apparent, however, that, to be able to raise substantive revenues from carbon taxes, we need a lot of carbon. A tax that raises considerable revenue initially, but phases out carbon, will have a negligible budget impact after 10 years or so.

QUESTION 4:

Grassley: Democrats have consistently claimed in our hearings that climate change presents a systemic risk. Is this true?

Gomes: It is difficult for me to answer this question with a great deal of certainty. Economists reserve the term, “systemic risks” to describe the risk of inducing a cascading failure throughout the economy, and most commonly apply it to the financial system. […] It seems likely that the bulk of the climate risks we face are redistributive rather than truly systemic.

QUESTION 5:

Grassley: Chairman Whitehouse frequently cites a September 2021 International Monetary Fund Working Paper titled “Still Not Getting Energy Prices Right: A Global and Country Update of Fossil Fuel Subsidies” when attempting to assess the cost of climate change to discredit the costs of his extreme climate change proposals. This study has been consistently debunked throughout our numerous hearings. Can you identify any problems with its underlying economic assumptions?

Gomes: As I indicated in my answer to Question #3 above, the report’s estimates of the (net) benefits of energy taxes to the U.S. economy of over 1% of GDP, largely due to increased tax revenues of about $400 billion, are greatly misleading. This estimate fails to account for the – almost surely recessionary - impact of a near doubling in energy prices on the overall U.S. economy.

QUESTION 6:

Grassley: The Chairman referenced Deloitte research during the hearing, which allegedly reveals that inaction on climate change could cost the world’s economy $178 trillion by 2070. Can you identify any problems with this research and its underlying economic assumptions?

Gomes: I found the quality of the economic analysis in this work to be extremely poor. The writing is almost purposely confusing, failing to discuss key modeling assumptions. 

During my testimony, Senator Whitehouse used this study to suggest that the cost of climate change was equal to $178 trillion. This number is indeed the report’s headlines, but it is the report’s estimated worldwide cost of climate change. The corresponding costs for the U.S. are estimated at $14.5 trillion.

Importantly, however, the estimated benefits of decarbonization are far smaller than the costs of climate change. Although the wording in the report greatly obscures this fact, it is very clear from Figure 3 in the report..., that the proposed mitigation only partially reverses the impact of climate change on the economy. For policy purposes, the relevant numbers are the estimated gains from mitigation policies. The report places the present value of these at $3 trillion in the U.S. and $43 trillion worldwide. 

Finally, these estimated gains depend crucially on the “interest rate” used to discount GDP improvements which only take place well after 2048. Although this crucial choice is only discussed in the report’s technical appendix, the authors use a low discount rate of 2%, on “social” grounds, and perform no sensitivity analysis at all. 

I believe this is an unrealistically low choice. […] Given our best current estimates of average market risk premia, I believe that a real discount rate in the range of 6%-8%, more accurately capture the GDP risks in these estimates. This is also very much in line with the Office of Management and Budget’s (OMB) Circular A-4.

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