JCT’s Dynamic Score is Positive But Underestimates Economic Benefits
November 30, 2017
With today’s release of a dynamic scoring estimate of the Senate’s version of the Tax Cuts and Jobs Act, the Joint Committee on Taxation (JCT) confirms that tax changes impact economic growth. While JCT’s estimates are positive, there is reason to believe that the tax plan would produce even greater dynamic effects than its analysis shows.
JCT estimates that the federal government would see an increase in revenue of $458 billion over the next decade from the economic growth, while growing the nation’s GDP on average by 0.8 percent. While the static cost of the bill is still estimated to be almost $1.414 trillion, the overall costs are now lower at approximately $1 trillion.
This range of estimates highlights the importance of JCT providing Congress with dynamic estimates, and reflects years of JCT’s hard work to develop this model.
However, JCT’s results should be viewed as likely underestimating the economic growth spurred by this tax bill. The range of estimates from JCT includes several important assumptions that limit its growth results, particularly, assumptions regarding the Federal Reserve’s response to potential inflation and the United States being an open economy that assumes financial flows don’t change quickly. This, in practice, makes the results more similar to those of a closed economy.
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.
Second, 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.