Four Reasons Why We Need Dynamic Scoring
August 5, 2015
The Joint Economic Committee hearing last week discussed the importance of dynamic scoring —a method of estimating the effects of policy changes on the economy. Earlier this year the House of Representives passed a rule requiring dynamic scoring of future bills. Congress had previously relied on conventional, static scoring to analyze such effects. Static and dynamic scoring are very different in the assumptions they employ, and therefore the results they produce.
Static scoring assumes that tax changes don’t affect behavior of individuals and firms, and therefore have no impact on growth. Dynamic scoring, on the other hand, assumes that tax changes influence the amount of savings and investment—the engine of economic growth. As the amount of savings and investment change, the overall economy changes as well. Failing to take account of such a simple economic relationship results in misleading forecasts.
The need for dynamic scoring was recently emphasized to the committee by four prominent experts on the matter. Their main points were as follows.
1. We need to understand the real cost and benefit of a policy proposal
When Congress enacts a policy, it needs to have an idea of how that policy affect taxpayers, businesses, and government revenue. However, the static estimates that Congress has been using as a guide hide the true cost/benefit of a policy change. This was the view presented by Dr. Phil Gramm, former Chairman of the US Senate Committee on Banking, Housing, and Urban affairs. In his testimony, Gramm argued that:
If a policy change is likely to affect the economy, based upon a logically consistent theory, and good empirical evidence that similar policies have had significant effects on the economy in the past, we should always attempt to employ dynamic scoring.
2. The effect of taxes on economic growth is part of the policy debate
In a world of increased global competitiveness it is imperative that the US government adopt policies that promote competitive economic growth. Dynamic scoring estimates the effect of policy changes on economic growth. Without dynamic scoring, lawmakers won’t have the information necessary to select policies that most benefit the economic health of the country. As Dr. John Diamond from the Baker Institute of Public Policy argued, “We can’t afford policy changes that don’t create growth.”
3. Without dynamic scoring, tax reform discussion is going nowhere
Major reform of the US tax code – broadening the tax base and making rates more competitive – can improve the wellbeing of Americans. But tax reform has not been seriously discussed since the 1980’s. The US is now ranked third last on the International Tax Competitiveness Index. Dr. Kevin Hassett, an economist at AEI, stated before the Committee that “one reason we have made such little progress is that scoring methods do not account for the impact that sound proposals would have on the overall economy.”
4. Conventional scoring underestimates the benefits of tax cuts
Because of the assumptions behind conventional scoring, the benefits of tax cuts tend to be underestimated.
Dr. Gramm gave an example during his testimony on how far off CBO’s static projections were compared to reality. CBO predicted that the bipartisan “Balanced Budget Act and the Taxpayer Relief Act of 1997” — an attempt to balance the budget by spending cuts and tax cuts — would create $120 billion revenue between 1995 to 2001. In reality, nominal GDP between 1997 and 2001 beat CBO’s expectation by $2.4 trillion. That averaged out to be $480 billion per year higher than CBO’s forecast. That piece of legislation added an extra $8,609 in per capital GDP during those five years.
Skeptics would argue that dynamic scoring is merely a tool to justify a tax cuts without having to pay for them. Ranking Member Rep. Carolyn Maloney (D-NY) stated in her remark that dynamic scoring “strongly biases policy towards tax cuts.” But history proved tax cuts actually stimulated growth.
Dr. Hassett explained why conventional scoring underestimates the benefits of tax cuts and why dynamic scoring is a better tool for Congress:
In a world of conventional scoring, no tax cut can be estimated as likely to “raise all ships” by raising the level of overall macroeconomic growth. This is because conventional scoring, by construction, only permits changes to the composition rather than the level of economic activity. Thus, current practice focuses one-hundred percent on questions of distribution, treating tax cuts as mere alterations in who gets the benefits of a fixed level of aggregate economic activity. Such a focus has no economic merit. Policymakers, of course, should consider issues of distribution when considering policy alternatives. But to look at distribution only, without regard to economic efficiency, is to deny the basic tradeoff between the two, and frankly, to deny the value of economic analysis whatsoever.
Dynamic and static scoring are both tools for providing Congress with the information they need to make decisions on tax policy, but there is a clear difference between them. As the Tax Foundation’s President eloquently put it:
Conventional scoring methods provide [congress with] a very one-dimensional perspective about the effects of tax changes. By contrast, dynamic scoring gives lawmakers three dimensional information they can use to understand the effects of tax policies on a complex, multi dimensional US economy
The gradual move towards dynamic scoring has been long awaited by advocates of a strong economy. It will help representatives make better policy decisions that will boost growth and improve living standards for all Americans.