President Bush’s 2007 budget, released in February, proposed spending $513,000 for a dynamic-analysis unit within the Treasury Department. The unit would not initially conduct dynamic analysis or scoring — which represents an attempt to summarize, as a cost estimate, the impact of policy changes on revenue estimates — but it would advise federal policymakers on how tax-rate revisions might affect economic aggregates. That’s an improvement over the current state of affairs, and a modest breakthrough for economists who argue that static models fail to capture the dynamic effects of tax cuts.
The congressional Joint Committee on Taxation (JCT) and the Treasury Department’s Office of Tax Analysis (OTA) develop revenue estimates, and in the process they use static models that assume some aggregates will not be altered by rate revisions. Dynamic scoring, however, attempts to measure the feedback-effects ignored in these models — those feedback-effects potentially becoming excellent ammunition for supply-side policymakers and tax-cut advocates.
There’s no doubt that dynamic scoring is today being taken seriously within the budgeting community. More, the overall tone of the debate has evolved from theoretical to practical.
For instance, a Heritage Foundation book, The Secret Chamber or the Public Square?, discusses the issues involved in making tax analysis and revenue estimation more transparent to citizens — in other words the voters who need to understand the dynamic effects of tax cuts. This is a very pragmatic idea. Retired banker and Lone Star Foundation chair David A. Hartman argues correctly in the foreward that “Better scoring and analysis will help achieve the optimal tax reform objectives for U.S. competitiveness and growth of outputs and incomes.”
Another way to increase transparency, a very practical goal of dynamic-scoring advocates, is to require more disclosure of the methods used to develop revenue estimates under the Freedom of Information Act. Martin A. Sullivan, a JCT and Treasury veteran, notes in an essay that “it is arguable that the current practice of limited disclosure creates its own biases.” The JCT permits limited review of some estimates, which according to Sullivan
means primarily that lobbyists or staff members (at lobbyists’ urging) can get to second-guess the estimates. Full disclosure of methods would make it more likely that academics, the press, and public-interest groups might be able to counterbalance estimating biases introduced by special interests.
More importantly, as the debate over dynamic scoring heats up, we’re seeing more and more evidence that dynamic scoring actually works. Harvard professor N. Gregory Mankiw, who served as chairman of President Bush’s Council of Economic Advisers between 2003 and 2005, wrote in a 2004 paper that “The feedback [from dynamic scoring] is surprisingly large: for standard parameter values, half of a capital tax cut is self-financing.”
Long-time dynamic-scoring advocates, however, find nothing at all surprising about this. Simply, people respond to incentives, and tax cuts are incentives to work more, earn more, and invest more — all of which, in the end, lead to higher tax revenues.
According to Treasury employees Robert Carroll and Warren Hrung, attendees at the 2005 annual meeting of the American Economics Association where JCT and CBO employees presented papers on dynamic scoring, measuring the behavioral responses of individuals to tax-rate revisions is an important part of budget scoring. They also confirm that professional interest in the subject is on the rise: “After consisting of only a few papers, interest in the overall taxable income response received increasing attention in the wake of the 1993 tax rate increases with a number of papers finding sizable tax rate effects.”
To be sure, there is no universal shift toward advocacy of dynamic scoring within the professional ranks. But there does seem to be an overall sense that “dynamic” is no longer the dirty word it used to be when it comes to scoring revenue.
Berkeley professor Alan J. Auerbach, who spoke at the AEA event, offers a balanced summary of arguments both in favor of and against dynamic scoring, and how it might be carried out. “From these first attempts,” Auerbach says,
it seems clear that dynamic analysis has value, but also that adjustments to estimates are smaller than some might have expected. The process to date offers some support to those on both sides of the debate.
On the one hand, the ability of CBO and JCT to produce dynamic analyses of complex, realistic proposals lends credence to the argument that dynamic analysis and, indeed, dynamic scoring may be feasible. On the other hand, many models used and the many assumptions needed will leave many with doubts about the quality of these estimates and how they would fit into the budget scoring process as currently structured.
That said, free-market advocates who have toiled in the economic vineyards for years can take some solace in knowing that dynamic scoring is being examined on academic and political levels. Indeed, President Bush’s proposal for a dynamic-analysis unit within the Treasury illustrates that the topic is being taken seriously by policymakers.
But the solution to the legitimate issues identified by professor Auerbach and other scholars is to let a thousand scoring models bloom. And it’s in this way that competition in the marketplace, over time, will solve the problem of errant forecasts.
Let the most accurate forecasting models win (although dynamic models would have to be considered the heavy favorites).
– Greg Kaza is executive director of the Arkansas Policy Foundation, an economic research organization founded in 1995 in Little Rock.