Oral Testimony before the Subcommittee on Select Revenues Measures of the House Ways and Means Committee on the Dynamic Analysis of the Tax Reform Act of 2014

July 30, 2014

Hearing on Dynamic Analysis of the Tax Reform Act of 2014
Before the Subcommittee on Select Revenues Measures of the House Ways and Means Committee

Chairman Tiberi, Ranking Member Neal, members of the Committee, thank you for the opportunity to speak with you today about dynamic analysis of the Tax Reform Act of 2014.

There are many good reasons to reform our tax code, but economic growth ought to be the primary objective. While we all may want a simple and more equitable tax code, if simple/equitable code actually reduces economic growth then we should think twice about those policies.

And this is why dynamic analysis must be an essential tool of any effort to reform the tax code. There are many base broadeners that seem like a reasonable tradeoff for lower rates when measured on a conventional basis, but actually turn out to be anti-growth when measured on a dynamic basis.

In order to do tax reform right, members should be provided a dynamic analysis of each component of the plan as it is being constructed, not just at the end of the process. Only then, will members know which components maximize growth and which retard growth.

However, economic growth should not be an accidental outcome of the process, it should be initial goal of the process. Before even beginning to think about how to reform the tax code, lawmakers should set out a target for how much additional economic growth they hope to achieve as the result of the tax overhaul. Any policy that subtracts from that goal should be replaced with policies that move closer to the goal.

Modeling the Camp Draft

Chairman Camp deserves a lot of credit for undertaking the Herculean task of drafting a comprehensive tax reform plan. The Chairman’s plan has many positive features that, by themselves, would promote growth and competitiveness. Chief among these are cutting the corporate and individual tax rates to 25% and eliminating both AMTs.

When we modeled these policies in isolation with no offsets, we found that they would boost GDP by nearly 5 percent, increase after-tax incomes by more than 7 percent, and create more than 5 million jobs.

We also found that these rate cuts lost less revenues when measured dynamically—within the ten-year budget window the corporate rate cut would be 59 percent less costly and the individual rate cuts would be 21 percent less costly. This means that the tax reform plan should have required fewer offsets had members been provided this information at the beginning of the process.

However, we find that many of the offsets that were required to keep the Chairman’s draft revenue neutral on a static basis had the effect of dampening the growth potential for the plan.

We modeled the economic effects of the Chairman’s draft using our Taxes and Growth Dynamic Tax Model.

Overall, we found that the domestic provisions of the reform plan would increase GDP by 0.22 percent over the long run.

However, the plan would raise the cost of capital in a variety of ways which would reduce the capital stock modestly, which would slightly decrease pre-tax wages.

But, because the plan reduces marginal taxes on labor income it would raise after-tax wages slightly and that, in turn, would encourage more labor force participation and hours worked—equivalent to adding about 486,000 full-time jobs.

What this means, though, is that people would be working longer but producing less total output with less capital.

Alternate Simulations of the Camp Draft

However, we found that modifying a few of the plan’s provisions that raise the cost of capital could generate far more economic growth, investment, and jobs.

  • For example, just maintaining the current MACRS depreciation system—as opposed to the ADS system outlined in the draft—would boost GDP by 1.3 percent over the long run, increase the capital stock by 2.95 percent, and create 685,000 full-time equivalent jobs.
  • In a similar way, we modeled the original Camp draft with 50 percent bonus expensing and found that such a plan would increase GDP by 1.8 percent, the capital stock by 4.4 percent, and create the full-time equivalent of 780,500 jobs.

Transparency Would Improve the JCT’s Dynamic Analysis

Before I conclude, I do want to say that the Joint Committee on Taxation deserves credit for their dynamic analysis of the Chairman’s plan.

However, the JCT invites criticism of its work because of the opaque way in which it presents its results and its lack of transparency in documenting how it produces the results that it does.

JCT has made substantial changes to their models over the past decade and it is time they subjected those changes—and the core models—to a review by experts in the field.

If members are to have any confidence that JCT’s estimates are accurate and that it is using state of the art tools, then JCT must allow outside economists access to their models for peer review—as they did in their 1997 and 2001 review panels.

Transparency is the key to removing the image that JCT is operating a black box and the key to members of Congress getting reality-based analysis.

Conclusion

Despite the criticism, what dynamic scoring is really about is accuracy, credibility, and having tools that guide us toward tax policies that promote economic growth and steer us away from policies that reduce living standards.

By contrast, conventional static analysis leaves lawmakers in the dark about the economic consequences of their tax choices. That is economic malpractice.

Relying on static scoring turns tax reform into an exercise in arithmetic, rather than an exercise in promoting policies that raise peoples’ living standards and the health of the private economy.

Thank you Mr. Chairman. I’m happy to answer any questions that you may have.


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