Regular readers of Tax Foundation reports know that we publish estimates of the distributional impact of federal tax changes: that is, we estimate how a tax reform might affect the after-tax incomes of taxpayers at...
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- The Common Sense of Dynamic Scoring
The Common Sense of Dynamic Scoring
When considering a lower tax rate we can make one of two assumptions. We can assume that changes to taxes rate will not change behavior, or we can assume that changes to tax rates do change behavior.
We know that taxes do alter behavior. In Washington, DC, we see it on a small scale every day when people decline a plastic bag at the grocery store because of the 5 cent bag tax. When we see people make such a decision over 5 cents, we know that major tax changes can have large impacts on costs and behavior all over the economy.
Dynamic scoring pays attention to how a tax change increases or decreases the price of two key goods, capital and labor. The price of capital and labor are used to estimate how individuals and businesses change their behavior; and in turn, how changes in behavior effect the economy as a whole.
This isn’t how Congress’s tax scoring committees currently function. When Congress’s tax scoring committees estimate the revenue cost of a tax bill, they often make the first assumption—that taxes do not affect behavior in a meaningful way. This is called static scoring.
Static scoring follows the simple rule; if you lower taxes by $1, you also lower revenue by $1.
Instead of making tax policy an exercise in budget arithmetic, dynamic scoring requires policymakers to consider the quality of the tax change—how does this tax change affect people’s incentives to work or invest?
Modeling tax policy’s dynamic effects on the economy allows policymakers to ask the question: is the tax policy pro-growth?
Good tax policy is not always about indiscriminately lowering rates. Congress is currently considering the biennial “tax extenders package” which will reauthorize a long list of tax expenditures. A small portion of these expenditures are actually good tax policy because they help treat consumption and investment similarly. Under a static tax model Congress may be tempted to cut these beneficial expenditures, because their model assumes they will get a dollar for dollar increase in revenue.
The problem is, that many of these tax expenditures are deliberate offsets to what would otherwise be taxed two, three and four times. A dynamic tax model shows which expenditures are true loopholes, and which are beneficial. Trading beneficial expenditures for lower rates could slow growth and actually decrease revenue.
Another benefit of dynamic scoring is the ability to account for increases in tax revenue gained from a growing economy. Simply cutting the corporate rate will unleash economic growth that will in turn increase revenue collection. A more accurate forecast of future revenue collection could allow more of the beneficial expenditures to remain in the code. Dynamic scoring allows policy makers to more accurately assess the total impact of changes to the tax code on both revenue and the economy.
Currently, Congress doesn’t pay much attention if a tax change will be pro-growth or not. Most legislators are primarily concerned with the revenue effects projected by their tax scoring committees. This is not a productive metric when the scoring is done on a static basis. The question legislators should ask is: what is my bill going to do for job creation and wages? Dynamic scoring can answer that question.
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