Dynamic scoring and the CBO

Posted: Aug 15, 2002 12:00 AM
In earlier columns, I have written about the issue of "dynamic scoring." This is an issue because the current way that the revenue impact of tax changes is calculated -- called static scoring -- leaves out any impact on economic growth. Consequently, the revenue loss from tax cuts tends to be overstated, thereby making it harder to enact them. Conservatives have been complaining about the use of static scoring by the Congressional Budget Office ever since that agency was created in 1974. Now, under congressional pressure, the CBO is finally taking some baby steps toward implementing dynamic scoring. On Aug. 7, it convened a conference at which several supporters of dynamic scoring were invited to make their case. These included economists Bill Beach, David Burton, Steve Entin and myself. Not surprisingly, the CBO is deeply reluctant to change its standard methodology. This is typical bureaucratic behavior. Bureaucrats always have 10 good reasons for maintaining the status quo, against every one raised in favor of changing it. This is true regardless of the party in power and is probably, on balance, a good thing. But unless bureaucrats are forced to defend their position from time to time, they become complacent and lazy. Sometimes, resistance to change is just an excuse to avoid doing real work. There is no question that dynamic scoring is harder work than current methods. After all, it is a lot easier just to assume that nothing changes in the economy when a major tax change is enacted than to figure out all the ways in which it will. However, I don't think CBO economists are being work-averse in opposing dynamic scoring. They are much more concerned about leaving a well-trod path for parts unknown. Still, the effort is worthwhile. At present, there is a systematic bias in the revenue-scoring process that encourages tax increases and discourages tax cuts. Look at it from the point of view of members of Congress. In the former case, they are told that a 10 percent increase in tax rates will raise 10 percent more revenue, when in fact it will raise perhaps 7 percent. In the latter case, they are told that a 10 percent tax rate reduction will lose 10 percent revenue, when it probably will only lose 7 percent. Over time, members of Congress tend to use tax increases to reduce deficits more than they would if they had accurate scoring data. Conversely, they enact smaller tax cuts than they might otherwise do when political pressures force them to do so. Over time, there is a ratchet effect that causes government's share of the economy to rise inexorably. Another problem is that revenue changes are calculated against a "baseline" that implicitly assumes everything will stay the same. But this is unrealistic. In the case of tax rates, they are never stable. Generally, they rise because of inflation and real growth in the economy, which pushes people up into higher tax brackets. Therefore, unless taxes are cut from time to time, the effect is to mandate a continuous tax increase. Interestingly, the CBO provided strong evidence on this point at the conference. Its data show that if the 2001 tax cut had not been enacted, the average marginal tax rate (the tax on each additional dollar earned) on labor income would have risen automatically from 21.1 percent in 2001 to 22.5 percent in 2011. Thus, opposing the tax cut was equivalent to voting for a tax increase on workers. Although liberals continually complain that last year's tax cut is the sole and exclusive cause of the current budget deficit, a new CBO report shows that only 20 percent of the decline in revenues this year, as projected in January 2001, is due to the tax cut. Eighty percent results from technical and economic factors that would have occurred even if no tax cut were enacted. Furthermore, the CBO shows that this "huge" tax cut has had very little impact on economic incentives. The average marginal tax rate this year is 20.5 percent, just 0.6 percent less than last year. Because the marginal rate cuts -- those that actually affect economic growth -- are phased-in slowly, they will not have their full effect until 2006, when the rate falls to 19.9 percent. But after 2006, rates ratchet up again. By 2010, the average marginal tax rate will rise again to 20.7 percent. In 2011, when the entire 2001 tax bill is automatically repealed under current law, the rate shoots up to 22.5 percent. The CBO's own analyses shows that during the period when rates are falling, they significantly raise the real economic growth rate. When tax rates rise again, they depress growth. It seems like nothing but common sense to include these effects in the scoring. Member don't just need to know the revenue effects of tax changes. They also need to know how they affect the economy.