As part of “Vote-o-rama” this past Saturday, the U.S. Senate voted 51-48 to “require the Congressional Budget Office to include macroeconomic feedback scoring of taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. legislation.” Even though this is likely non-binding, it shows the majority of the Senate recognizes that CBO revenue estimates are unrealistic in that they do not account for any effects on the larger, “macro”, economy. That is, when income taxes go up, for example, the CBO ignores for purposes of revenue estimation how this might change incentives to work, save, or invest. This is clearly wrong by any school of economics, yet this “static” analysis is what determines the official revenue estimates for every tax bill passed by Congress. It is a shame that 48 Democrats, including chief Senate tax writer Max Baucus, voted to continue ignoring how taxes actually affect the economy and how that in turn feeds back into tax revenue.
It is not as if the CBO is unprepared to do a more realistic analysis, which is sometimes called “dynamic” or “macroeconomic” analysis. The CBO relies on the Joint Committee on Taxation (JCT) to estimate revenue changes from legislation, which has at its disposal three macroeconomic models that all take into account to some degree how taxes affect the labor supply, savings and investment, and GDP. These macroeconomic models could be used to provide more realistic estimates of revenues, as a supplement to JCT’s standard analysis. However, it appears the last time JCT used these macroeconomic models at all was in 2009 to estimate the effects of the Affordable Care Act.
To be clear, JCT in their standard analysis does account for certain behavioral effects which they describe as “dynamic”, namely:
- Tax planning behavior to minimize taxes, such as income shifting or timing changes.
- Shifts in consumption or production that do not affect the overall aggregate measures of the economy, such as a cigarette tax that reduces cigarette consumption and shifts employment and investment out of the tobacco industry and into other sectors.
However, JCT’s standard analysis explicitly ignores any of the big effects of tax changes that affect the overall size of the economy, such as higher income taxes causing less work and investment overall:
“A conventional JCT estimate incorporates behavioral responses in projecting tax revenues, but assumes that these tax and behavioral changes do not change the size of the U.S. economy, as measured by the Gross National Product (“GNP”).”
Failing to account for these big effects biases tax policy against economic growth, as it pretends that higher income taxes in particular won’t hurt the economy. JCT’s macroeconomic models hold the potential to do a much better job, and Congressional tax writers should at least demand they be used and the results published. Additionally, Congress should look to outside groups such as ours to independently estimate the effects of tax changes. An open discussion of the various models, and their underlying assumptions, would greatly improve the tax writing process.
Follow William McBride on Twitter @EconoWill
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