The Joint Committee on Taxation (JCT) produced a dynamic score of the Senate tax plan. While it is good news that the committee has agreed to move a step closer to reality with its scores, there is a lot left to be desired.
Here are the main findings: Under the Senate’s version of the bill, the economy would grow by 0.8 percent annually, and the macroeconomic feedback revenue would range from $250 billion to $495 billion. By contrast, the JCT finds that the tax plan introduced a few years ago by former Ways and Means chairman Dave Camp would grow the economy more and would give it a range between $50 billion and $700 billion.
This is pretty bizarre. First, most analysts have projected much more growth as a result than the JCT, based on the many pro-growth provisions in the plan. To name just one, a recent Quantria/Inforum study’s dynamic score of the Senate bill projected around $1.1 trillion in tax revenue. When Quantria scored the bill against a current baseline (one that realistically accounts for tax credits that will not expire and spending that won’t be cut), the score shows no revenue gap. Some other nonpartisan economic models have also found that the GOP tax framework generates over a $1 trillion increase in new revenue as a result of increased investment, productivity, and overall economic growth. But not JCT.
Even more bizarre is the finding in the JCT score that the Camp plan would produce more growth and revenue than the Senate Finance bill. This again goes against most analysts’ assessment of both the Senate and the Camp plan. The senate plan produces more growth than the Camp plan in part because of the Senate’s lower corporate tax rate (20 percent permanently as opposed to the 25 percent Camp rate). The Senate plan also has many more pro-growth provisions on the expensing and investment sides, and better incentives to work on the individual side.
How on earth could more pro-growth provisions overall in the Senate bill than in the Camp plan produce less growth and less revenue in the JCT score? If the Senate bill were ever implemented, this specific JCT score would have to join many other scores that were widely inaccurate. As Jack Fowler noted this morning:
The Great Oz has spoken? But maybe its record should earn the Committee a bit more of a reputation as The Man Behind the Curtain. For example, in 2003, when scoring the Bush tax cuts, the JCT predicted it would lead to massive revenue declines. The reality: Between 2003 and 2007, tax revenues were $434 billion higher than JCT had forecast, as the economy grew at an average of 3 percent annually. Underestimating and lowballing the economic growth that comes from major tax-cuts seems to be the hallmark of many experts.
The Tax Foundation suggests two reasons for the likely flawed score. First, they note that the JCT assumes that the US is a closed economy. They write:
As we’ve long argued, the United States is not a closed economy, but rather functions as a small, open economy. While the United States represented approximately 40 percent of the world’s economy in the 1960s, that is now less than 25 percent, with large international capital inflows annually. This matters, because assuming the United States is a closed economy assumes that capital is not available to help finance the rapid increase in economic growth.
Without an open economy, U.S. businesses are limited to U.S. savings for investment, which is being eroded by increased government borrowing. This crowds out the opportunity for small business to invest because the limited savings bids up the cost of borrowing.
However, when savings from foreign investors is available, U.S. businesses have access to a plethora of savings. As long as there are economically viable projects, foreign investors funnel savings into the United States to take advantage of the opportunity. Moreover, U.S. investors with assets in foreign countries can choose to sell their investment abroad and purchase U.S. assets. This is another channel by which an open economy draws in investment from the rest of the world.
The second reason is the JCT’s assumption about the response of the Federal Reserve to potential inflation. They write:
JCT assumes that the Federal Reserve accommodates the increased demand for investment by keeping rates low or attempts to fight inflation by raising interest rates through its open market activities. The JCT’s score includes Federal Reserve activity that would counteract the economic expansion from tax cuts.
JCT’s assumption on an aggressive Federal Reserve also doesn’t seem quite reflective of the current U.S. economy. Historically, the Federal Reserve has been conscious about rapidly changing the interest rate. Rapid changes often create unintended consequences. Given the interest rate is functionally near zero, it is unlikely that the Federal Reserve will increase the rate above and beyond its current schedule, which has already been priced into the economy.
This is a big deal, and an important difference ignored in other scores of the same bills. This is particularly frustrating because JCT and CBO both have a terrible track record of over-estimating future increases in interest rates. As a result, the scoring shops time and time again offer far too pessimistic projections of how much of the private investment will be crowded out by a larger amount of resources the federal government has to devote to servicing federal debt.
Since they always make that mistake, shouldn’t they try to get better at it? Or at least they could try to learn from their mistakes and offer more realistic projections. It’s not as if they haven’t been told about it before. That would be too simple, I guess.
Yet now, because of this very questionable score, the passage of the Senate bill is facing turbulence again. Not to worry, there are ways that senators can address the dilemma: First, they should learn to take these government scores with a grain of salt, and second, they should cut spending. In the next ten years, the federal government is set to spend at least $48 trillion. Surely there is room to cut. Also, as I explained in this paper, they can always start eliminating more tax loopholes. I make many suggestions that would go a long way toward addressing the Senate’s math problem.