Congress and the White House are moving closer to finalizing the details of a tax reform plan and legislation is expected soon. As we saw with battle over proposals to repeal and replace the Affordable Care Act, the fate the tax plan that eventually emerges will be shaped by the scorekeeping analysis estimating its effects on the budget and the economy. While several think tanks provide such analyses, scores from the Congressional Budget Office (CBO) generally receive the most attention as the official scorekeeper of Congress. CBO only began incorporating dynamic scoring into its estimates following a concurrent resolution in the FY 2016 budget. Taxpayers should be grateful that tax reform legislation will receive CBO scores that more accurately portray the economic effects of legislation than static scores, even if the CBO model is still imperfect.
Dynamic scoring is a budgetary scoring method which incorporates macroeconomic effects of changes to taxation or spending policy. The older method, static scoring does not attempt to measure the common sense changes in economic behavior resulting from tax or spending policies. For example, a static analysis of raising income taxes by 25 percent on every American would, on paper, appear to raise a great deal of revenue in the short term, such a policy would reduce individuals' incentives to earn more and reduce their income, causing lasting damage to the economy; the result would be that revenue would rise by substantially less than 25 percent. While static scoring would show only the increased revenue, dynamic scoring would incorporate the economic harm into future revenue projections.
In the years prior to the concurrent resolution that required CBO to adopt dynamic scoring, the agency faced heavy pressure by economic experts to do so. In late 2014, NTU president Pete Sepp signed a coalition letter of 45 organizations demanding reform to CBO scoring methods. Even left-leaning organizations such as the Brookings Institution have expressed support for dynamic scoring.
A practical effect of static scoring is that it makes “tax and spend” economic policy appear to be more appealing by not acknowledging the harmful effects high taxes have on the economy. Conversely, policies friendly to the American taxpayer are made to look less practical. In the case of tax reform, static scoring of tax cuts shows only lost revenue, allowing opponents to point to “costs” as being too extreme. Dynamic scoring, however, incorporates increases in wages, investment, and employment (and by extension federal revenue from the larger tax base.) While dynamic scoring assumes that you would attempt to duck a punch, static scoring assumes that you would stand still and take it in the face.
Besides alleviating the arbitrary bias static scoring has towards higher taxes and higher spending, dynamic scoring is also more helpful for comparing different tax policies against each other and illustrating tradeoffs; different tax cut policies can have vastly different effects on economic growth. Tax Foundation studied five different tax cuts, each of which had a static impact on annual revenue of $72 billion. The estimated percentage change to GDP growth for each policy was as follows:
Even with these improvements, CBO’s scoring methodology is still far from perfect. CBO incorporates a “positive multiplier” effect into its estimates of the economic impacts of increased government spending. The assumption is that government spending will trigger a cascade of new spending as the dollars spent by the government are passed through the economy. However, this fails to account for the “negative multiplier” which comes from the government taking a dollar out of the economy in order to pay for its spending, either through taxation or borrowing. As such, CBO continues to overestimate the economic benefits of government spending.
Tax reform can be a complicated topic, but it is important that taxpayers have the best information available to them. While CBO modeling is still imperfect, Americans should see the example of dynamic scoring as an example of how CBO can be reformed for the better.