May 2, 2002

The Florida Senate
404 South Monroe Street
Tallahassee, FL 32399
Dear Florida Senator:

The debate on the corporate piggyback bill is moving to the Senate floor in this special session. Consequently, it is essential that we all have a clear understanding of the facts associated with the issue.

Of particular interest is testimony to the Senate Finance and Taxation Committee last Monday by Ed Montanaro, with the Legislature's Office of Economic and Demographic Research (EDR). Based on some "in-house" econometric model runs under pre-determined assumptions, he concluded that it would be better for our economy to allow the short-term revenue from the corporate tax deferral to be used for increased government spending rather than productivity-enhancing business investment. I strongly disagree. EDR's analysis needs to be put into proper perspective.

The analytical tool that was used is the "REMI model," a very complicated and expensive model that simulates complex interrelationships in the economy under varying assumptions. Even with this great complexity, the model is, at best as good as the assumptions fed into the runs. These models are only appropriate to estimate rough and broad magnitudes of change under varying degrees of uncertainty. The model cannot predict positive behavioral investment changes due to more favorable depreciation schedules for private capital spending. This does not mean that in the real world there will not be any impact from passage of the corporate piggyback bill. It does mean that the REMI model is not made to capture such behavioral changes as the enhanced private-sector investment likely from greater after tax returns for new capital purchases.

Like so many econometric constructs that economists use, the model results depend crucially on what you feed into it. If the federal stimulus package induces an acceleration of investment, as most economists would agree, the REMI model will not, by itself, simulate or predict this. The internal structure of the model is not designed to do this. You have to tell the model how much the acceleration in investment is. The EDR analysis made no such assumption.

The conclusion reached by EDR is not surprising, given the assumptions plugged in the front end and given the internal structure of the model. But, if you accept without question the model's conclusions, then you could also conclude that taxing and government spending increases will bring net new jobs and income to the economy without limit. I think that most people would agree that such a conclusion runs against economic logic. Thus, it points out crucial limitations of the model for sound tax policy. Producers in the private sector of the economy are constantly changing investment decision-making. Their decisions, and the fortunes of states in which they locate, are driven by the need for efficiency and profit in a highly competitive global marketplace. The REMI model cannot begin to capture the dynamic nature of decision making in the private sector. It simply will not predict some things that economists suggest could happen, namely that lowering taxes can actually stimulate economic growth and productivity beyond what would otherwise occur. Higher productivity means higher wages and an improved standard of living for Florida workers.

It also fails to indicate that over the long-run new jobs created by the private sector will be sustained by private investment, while new jobs or services created by the public sector will have to be sustained by taxpayer dollars. Mr. Montanaro did point out that in the long run there may be net positive effects to the economy by shifting dollars to the private sector. This possibility was apparently discounted in the EDR analysis.

Very importantly, the EDR analysis also did not include any consideration of the higher private sector cost of administering a non-piggybacked tax code. This so-called "dead weight" cost of compliance hurts the competitiveness of Florida's businesses and thereby their ability to generate high wage jobs for our residents.

Mr. Montanaro's own words are very instructive when interpreting and using the results of the REMI model. It "does not give you the truth." It can serve as a guide. But to use the model as a guide means you need to understand how it works, what the inherent biases and assumptions are. Unfortunately, a full explanation of the assumptions, biases and shortcomings inherent in the REMI model was not given to committee members. Consequently, some Senators may be giving more credence to the EDR analysis than is deserved by sound economic and policy principles.
Sincerely,

J. Antonio Villamil
Chairman, Governor's Council of Economic Advisors

JAV/hmc