Predicting Policy Results Could Get a Deficit Deal
Policy + Politics

Predicting Policy Results Could Get a Deficit Deal

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The way things are shaping up, it may take a stiff dose of creative economics to salvage the Super Committee’s mission

With President Obama and Republican House Speaker John Boehner still miles apart on whether to include tax increases as part of any major deficit reduction plan, the challenge for the 12-member bipartisan committee is to find a way to generate long-term revenue growth without actually raising tax rates. Not so easy.

Since “supply side” economist Arthur Laffer sold Ronald Reagan on the economic-expanding wonders  of tax cuts back in the early 1980s, Republican lawmakers and administrations have pressed the Congressional Budget Office and Joint Tax Committee to use more “dynamic scoring” in estimating the long term impact of tax cuts or tax reforms.

The Super Committee is under orders by Congress to come up with recommendations before Thanksgiving for cutting $1.2 trillion or more of long-term deficits. Obama and the Democrats say the package must be a combination of spending cuts, entitlement reforms and tax increases; Republicans say spending and entitlement cuts are fine but tax increases are “off the table.” They say they will consider revamping the tax code in a revenue neutral way to eliminate wasteful tax loopholes while simultaneously reducing income and business tax rates.

The GOP approach would not raise revenues to help bring down the deficit on paper – unless, of course, Congress and their budget and tax scorekeepers followed new economic models and ground rules to evaluate the impact of the committee members’ plans on the economy and the long-term deficit. They would do that by jettisoning “static” economic models and embracing newer macroeconomic models that do more to anticipate the ripple effects and behavioral changes that likely would be brought on by a significant change in the tax code. In so doing, committee members could claim – with a straight face – that a substantial chunk of their deficit reduction effort could be achieved through an improving economy

“I think it’s doable – I always have,” said Douglas Holtz-Eakin,  former CBO director and White House economist who once helped President George W. Bush’s administration build its case that big tax cuts could at least partly pay for themselves by speeding up economic growth.

“It’s really a comparison of the world with the new policy versus the world without, and you want to capture as many of the impacts [of policy changes] as you can,” he told the Fiscal Times. “That’s simply good science. Some of the impacts are just hard to do. And they’re not special to taxes and they’re not special to spending. They’re just hard to do.”

For the most part, dynamic scoring has encountered heavy resistance and skepticism in Washington over the past 30 years. But with negotiations seemingly at an impasse, some Republican and Democratic members of the Super Committee are giving serious thought to using “dynamic scoring” in an unprecedented way to try to bridge their differences over tax and spending policy.

“It needs to be evidenced
based….You don’t want
politicians trying to rewrite
the rules for scoring.”

“Smart tax reform will result in more economic activity,” said Sen. Rob Portman , R-Ohio, a former White House budget director under George W. Bush and a member of the super committee.  “And additional economic activity will generate more revenue – not by raising taxes but by generating economic growth, which is what both parties want to see.”

Rep. Chris Van Hollen of Maryland, the ranking Democrat on the House Budget Committee and a member of the Super Committee was skeptical. “Whatever approach is taken, if anyone goes down this road, it needs to be evidence based,” he said.

“We should abide by the standards already set by the Congressional Budget Office and the Joint Tax Committee,” Van Hollen told The Fiscal Times Friday. ‘Those should be the basis for scoring, they are the umpires. You don’t want politicians trying to rewrite the rules for scoring.”

But Alice Rivlin,  the founding director of the CBO and an economist at the liberal-leaning Brookings Institution,  said that a shift to more dynamic scoring on the economic impact of major tax reform may be the only way for the Super Committee to reach consensus on a deficit reduction package.

“…You get into endless
wrangles about how much
growth do you expect
from different things.”

“if you mean on the tax side it will give the Republicans an excuse to say we can raise more revenues by lowering the rate and they make sort of optimistic projections, that could be something useful actually to get Republicans on board,” she said in an interview. “The unfortunate thing about dynamic scoring is the Democrats are going to want to do it too, and they’re going to want to say that investing in infrastructure will grow the economy, and then you get into endless wrangles about how much growth do you expect from different things.”

A leading skeptic, former Office of Management and Budget and CBO official Barry Anderson concedes the Super Committee could make a relatively strong case for dynamic scoring.  But members would have to take into account  the long-term effect and interaction of all elements of the deficit reduction package – and not simply  the impact of tax reform or tax cuts.  

“Could you do that? Sure you could,” said Anderson, who is now the deputy director of the National Governors Association. “Are you going to be able to do a precise estimate on it?  Of course not. But in an order of magnitude, economists do this all the time.”

“What I’m trying to argue here is that to pick and choose just the revenue portion without taking into account the spending portion is blatantly biased, because obviously there could be dynamic impacts of the spending side too,” Anderson added. “If they want to consider a dynamic impact, the first thing they should do is do it for the whole package.”

But taking Anderson’s more holistic approach to dynamic scoring would involve wading into the quagmire that Rivlin warned against, in which there would be no end to the economic feedback lawmakers might claim for their proposals.

Van Hollen, for example, has praised President Obama’s $450 billion jobs proposal, and said it would put many people back to work and get the economy moving again. Should Congress approve more spending on infrastructure and jobs this fall, CBO, using existing models, would assess the impact on the deficit and the potential impact on the economy, he said.   “But you don’t get indefinite [economic] feedback.”
In its purest form, dynamic scoring would take full account of all the effects of economic policies when estimating their budgetary effects.  A 2009 analysis by the Institute for Fiscal Studies in London says taxes and government spending have multiple economic effects. For example, individuals may respond by changing their behavior -- from deciding how hard to work to whether to continue in school to deciding what to purchase, how much to save and how best to operate their businesses. The questions are how much more inaccuracy and guesswork are likely to be introduced by trying to answer a more ambitious question.”

Laffer Throws a Curve
The controversy dates back to 1974, when a young economist named Arthur Laffer and his journalistic acolyte Jude Wanniski pioneered the concept of “supply side economics” and convinced President Reagan and his senior aides to sign on. These and other proponents of dynamic scoring claimed that traditional  scoring techniques undermined the case for tax cuts, as the full economic feedback effects of tax cuts were not fully credited.

Budgetary legend has it that Laffer sketched a curve on a cocktail napkin over lunch with then Reagan White House aide  Dick Cheney suggesting that a reduction in income taxes could spark the economy and raise revenues that would be more than enough to offset the cost of the tax cut. The graph demonstrated, not surprisingly, that tax rates at zero and 100 percent would generate no government revenue, since zero gets you nothing and 100 percent discourages anyone from working.

The problem was that the Laffer curve had no numbers on the axes – leaving unanswered questions about how much growth would be generated and at what level of taxation tax cuts would actually pay for themselves. Those questions have remained the great unknowns down through the decades.

In a forthcoming book, Fiscal Times columnist and former Reagan White House official Bruce Bartlett writes:

“The Treasury and JCT [Joint Committee on Taxation] now accept the principle that revenue scores ought to incorporate dynamic factors in order to improve their accuracy. But there are practical problems with doing a dynamic score that prevent its widespread use. First is that many proposed tax changes have no dynamic effects or de minimis effects too small to measure. A refundable tax credit for children, for example, is going to lose revenue dollar-for-dollar because it is essentially a spending program that runs through the tax code.”