Dynamic Scoring May Not Be Enough to Fulfill Tax Promises

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By Jonathan Nicholson

Republicans will be relying heavily on the promise of faster economic growth to keep their tax proposals from exacerbating the budget deficit.

But advocates of dynamic scoring say it is unlikely to show a permanent boost in the economy’s growth rate that Republicans promise and the think tank that has produced the most optimistic estimates of the impact of GOP tax proposals is under fire for the assumptions used in its budget scoring model.

Dynamic scoring is a relatively new development in the budget world. It attempts to quantify how much of a change in the overall economy a proposed bill would have and estimate the impact of that change on the bill’s cost.

Democrats say the method makes tax cuts look less expensive because of projected faster economic growth. Republicans say it gives lawmakers a better idea of whether a proposal would help or hinder economic growth.

‘Will Prove It.’

Officials in both the incoming Donald Trump administration and on Capitol Hill have made it clear they see dynamic scoring as crucial to passing the kind of sweeping tax overhaul they want, where most individual tax breaks are swapped out for lowered tax rates.

“Of course it works and of course you have to have dynamic scoring. It would make no sense otherwise,” Steven Mnuchin, Trump’s pick to lead the Treasury Department, said on CNBC Nov. 30.

Asked about objections that dynamic scoring was unproven, Mnuchin said, “Well, this administration will prove it.”

Similarly, House Speaker Paul D. Ryan (R-Wis.) said Dec. 7, “We will shoot for revenue neutral tax reform. The plan we wrote is revenue neutral. We now take into account economic effects of tax changes.”

At the heart of the Republicans’ argument is a contention that a tax overhaul will boost the long-term growth rate of the U.S. economy, lifting it from the 2 percent range it has been at since the end of the 2007-09 recession. Instead, they say it can be increased to 3 percent or 4 percent or even higher. Most economists are deeply skeptical about that prospect, given slow productivity growth and the graying of America’s labor force as baby boomers hit retirement age. The size of the labor force and productivity are widely seen by economists as the two main factors determining how fast the economy can grow.

Elmendorf: Not Plausible

Douglas Elmendorf, a former director of the Congressional Budget Office, said getting back to the 3 percent growth rate seen in previous decades is very unlikely.

“Some people will claim that certain policies can get you back to 3 percent growth and that will seem plausible based on historical experience, but it will not be plausible given the growth rate in the labor force we’re likely to see over the next decade,” he said.

“The growth in our labor force is now one percentage point below what it was for much of the past several decades,” Elmendorf said. “In order to get back to historic average growth rates, we would have to reverse the effects of the aging of the Baby Boom on people’s labor force participation, or we’d need to have productivity growth well above what we’ve seen for any prolonged period, at least since the Second World War.”

Even Scott Greenberg, an analyst with the Tax Foundation—a libertarian-leaning think tank that Republicans have been fond of citing for its dynamic budget scoring estimates—said a tax overhaul would likely bring only a one-time boost to the economy.

“Our model does not forecast that you can raise U.S. annual GDP growth in the long run,” Greenberg said. “You can raise it in the short-run by increasing potential GDP. It will grow faster in the short-run and then revert to the long-run trend growth rate.”

Crowding Out at Issue

The think tank has estimated that a House Republican plan to revamp the tax system is a revenue loser over 10 years, to the tune of $191 billion. The tax plan put forward by President-elect Trump was estimated to lose even more revenue, between $2.6 trillion and $3.9 trillion. Those price tags were calculated on a dynamic basis.

But other dynamic estimates by the Penn Wharton Budget Model group at the University of Pennsylvania reached different conclusions. The group is led by Kent Smetters, a former deputy assistant Treasury secretary in the George W. Bush administration and a former CBO economist.

The Penn Wharton model projected a $991 billion shortfall for the House Republican plan—almost five times the Tax Foundation tab—and a $2 trillion shortfall under the Trump plan.

Why the wide divergence in estimates? The Tax Foundation makes an assumption that both Elmendorf and a member of the Penn Wharton team said was unrealistic: that the additional government debt created by cutting tax rates wouldn’t crowd out domestic investment. Put another way, the Tax Foundation model assumes foreign investors will increase their investment in the U.S. enough to keep the increase in federal debt from making it harder to fund private sector projects.

‘Outside of Consensus.’

“Foreign investment is only about 18 percent of total investment, including government bonds, in the U.S. ,” said Kimberly Burham, managing director of legislation and special projects for Penn Wharton. “And so, 40 percent is an upper bound, at least for recent history.” In the Tax Foundation model, the implied assumption is 100 percent swapping out of domestic investment for foreign investment.

“To us, the 100 percent assumption seems to be an unrealistic assumption, much higher than what has been seen,” Burham said. “That’s why we wouldn’t choose that as our baseline.”

Elmendorf was more emphatic. “Assuming no crowding out of private investment from greater government debt over the next decade is outside of the consensus of economists who work in this area,” he said.

Beyond even 10 years, Elmendorf said, the picture gets worse. “The borrowing accumulates. If you’re borrowing more and more every year, that debt gets bigger and bigger over time and that’s why the crowding out tends to dominate as you get out to longer horizons.”

The Tax Foundation’s Greenberg defended the assumption, saying the extent of crowding is subject to debate in economic circles.

“It’s interesting to note that there are a whole lot of left-wing economists who tend to agree with us on this particular issue,” he said. “I wouldn’t necessarily say we’re out of the mainstream in this regard.”

All Estimates Uncertain

More importantly for Republicans, the CBO and Joint Committee on Taxation’s assumptions on crowding out are closer to the Penn Wharton model than the Tax Foundation one, meaning dynamic scores from them will likely show a tax overhaul along the lines contemplated as more expensive.

Despite the divergence between the Penn Wharton and Tax Foundation models, Elmendorf, Burham and Greenberg said dynamic scoring is still more appropriate for measuring the possible impact of a tax overhaul than the conventional method usually used.

“Estimates of dynamic effects are uncertain. But so are estimates of so-called non-dynamic effects in legislation,” Elmendorf said. “Policymakers and the public should always recognize that the point estimates provided by CBO or JCT or other organizations are points within sometimes broad ranges of possible effects.”

All three also said the public should look to the CBO and JCT estimates, even as other organizations make their own projections.

“At the end of the day, the scores that matter are the ones put out by JCT and CBO,” Greenberg said.

To contact the reporter on this story: Jonathan Nicholson in Washington at jnicholson@bna.com

To contact the editor responsible for this story: Paul Hendrie at pHendrie@bna.com

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