Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform – Why We Need It and What It Will Take.”
On March 22, the United States Senate adopted an amendment to S. Con. Res. 8, the concurrent budget resolution for fiscal year 2014, that would require the Congressional Budget Office and the Joint Committee on Taxation to produce estimates of the revenue effect of tax changes that incorporate their macroeconomic effects (Sec. 416).
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While seemingly innocuous, this amendment opens the door to “dynamic scoring,” which Republicans have long supported to make it easier to enact tax cuts and harder to enact tax increases. Tellingly, they reject the idea of dynamic scoring on the spending side of the budget.
The origins of the debate on dynamic scoring go back to the 1970s, when my former boss, Representative Jack Kemp, Republican of New York, used the “Laffer curve” to assert that an across-the-board cut in income tax rates of 30 percent would not lose any revenue. That is because the stimulative effect of the tax cut on the gross domestic product, employment, investment and so on would be so great and instantaneous that the tax base would expand more than the tax cut, he said.
The Laffer curve is named for the economist Arthur Laffer, who, according to legend, drew it on a napkin to show that there were always two tax rates that raised the same dollar amount of tax revenue – a high rate on a small tax base and a low rate on a large tax base. There is nothing controversial about this proposition, which economists from the time of Adam Smith have acknowledged.
The problem has always been estimating the curve empirically and calculating the impact of any particular tax cut at a given moment under a certain set of conditions. There is also the question of the appropriate time period over which to estimate revenue effects.
Generally speaking, supporters of dynamic scoring don’t offer any kind of serious economic analysis; they simply assert, as if it were self-evident, that the nation is always on the high side of the Laffer curve and that any tax cut will therefore pay for itself.
Pressed for evidence supporting this contention, supporters of dynamic scoring will point to the impact of cuts in the capital gains tax. But this is a very poor example because capital gains are a very special form of income.
Unlike wages, interest, dividends and rent, which are taxed when earned, capital gains are not. Gains that are not realized through the sale of an asset remain untaxed. Thus the stock of potentially taxable capital gains is much larger than the amount of gains that may arise in any given year.
A cut in the capital gains tax may unlock some of these gains, which may have arisen over decades, thus leading to a temporary surge in revenue. But it is important to recognize that the economy is not expanding when capital gains revenue rises, because the economic activity that gave rise to the gains occurred in the past. Comparing the revenue effect of a cut in the capital gains tax to the effect of an across-the-board tax cut on all forms of income is grossly inappropriate.
Another problem with dynamic scoring is that proponents often assert that if nominal federal revenue ever rises to the level before a tax cut, this proves that it paid for itself. Supporters of the tax cuts during the George W. Bush administration often state that since the aggregate dollar amount of federal revenue was higher in 2006 than it was in 2000, this is proof that the Bush tax cuts paid for themselves. (Revenue was well below its 2000 level from 2001 to 2005.)
This assertion is so ridiculous it hardly needs rebuttal, but since one still hears it, let me say that inflation raises nominal revenue and the economy generally grows over time whether taxes are cut or not. To observe that the nominal dollar amount of revenue is higher many years after a tax cut occurred tells us absolutely nothing about the revenue effects of that tax cut.
A better method would be to look at federal revenue as a share of gross domestic product. On this basis, the Bush tax cuts are still reducing federal revenue, which has yet to come close to where it was in 2000.
An even better method would be to look at projections of future revenue at the time a tax cut is made and compare the path of revenue with and without the tax cut, incorporating the effects on the economy. In 2003, the Heritage Foundation did just such an estimate – exactly what advocates of dynamic scoring propose.
The Heritage analysis shows that the 2003 Bush tax cut would immediately begin to expand the economy, offsetting some of the static revenue loss, which is the estimated revenue loss, assuming no change in the macroeconomy. In 2003, 8.8 percent of the static revenue loss would be recouped, rising to 14.6 percent in 2004, 28.5 percent in 2005, 47.5 percent in 2006, 73.7 percent in 2007 and 90 percent by 2011.
According to Heritage’s “dynamic” forecast, federal revenue should have reached $3.5 trillion in 2012 with the Bush tax cuts in place. In fact, they were only $2.5 trillion. Of course, Heritage was also wrong about the growth path of revenue without the tax cut. Economic growth over the last 10 years was far worse than anyone expected with or without the tax cut in 2003.
In principle we should want the revenue effects of tax changes to be calculated as accurately as possible, including their impact on the macroeconomy.
But this is a very time-consuming process, and the vast bulk of tax changes have no effect on the macroeconomy one way or another.
In practice, dynamic scoring is just another way for Republicans to enact tax cuts and block tax increases. It is not about honest revenue-estimating; it’s about using smoke and mirrors to institutionalize Republican ideology into the budget process. Why six Democrats joined the Senate Republicans in this move remains to be seen.
Article source: http://economix.blogs.nytimes.com/2013/04/02/dynamic-scoring-once-again/?partner=rss&emc=rss