Too Much "Static"

COMMENTARY Budget and Spending

Too Much "Static"

Jul 30th, 2002 3 min read

Senior Associate Fellow

The stock market is unsteady, but housing sales are strong. The accounting scandals have given Corporate America a black eye, but Federal Reserve Board Chairman Alan Greenspan says the economy is "poised" for real growth. Small wonder politicians in Washington are wondering what, if anything, they can do to ensure our economy is truly recovering.

One idea is to speed up last year's tax cut and make it permanent. Right now, the rate changes Congress approved are due to take effect in 2004 and 2006 … and are then repealed in 2011. If we implement them now, some lawmakers argue, we can begin enjoying their intended benefits -- higher levels of saving and investment, more jobs -- sooner. But they're running into opposition from colleagues who argue that sped-up tax cuts will cost too much. The cuts will cause Washington to take in less money, so we can't go that route.

Yet their claim makes sense only if one subscribes to what is known in Washington parlance as "static scoring" -- a method of doing business that past experience has thoroughly discredited.
Here's how it works: When lawmakers want to increase federal spending or make changes in the tax code, agencies such as the Congressional Budget Office "score" the proposals to determine how much they would cost or benefit the public treasury. And when they do, they don't take into account whether jobs will be created or people will have more money to save and invest. Instead, they use "static" analysis techniques -- simplistic formulas that assume people won't change their spending and investing habits one bit.

But in the real world, we know that businesses and consumers will respond to both tax cuts and tax hikes, and they do so in fairly predictable ways. Tax cuts spur investment, which spurs hiring, which spurs additional payroll taxes -- and that leads to a positive feedback effect for government treasuries. It's this feedback effect that static analyses miss.

It happened in the early 1960s, when President Kennedy's plan to cut the top marginal tax rate from 91 percent to 70 percent took effect. Total tax revenues actually climbed 4 percent, despite predictions the cuts would plunge the country deeply into debt. It happened again when President Reagan cut the top rate from 70 percent to 50 percent in 1982. Economists employing the models now in use at government agencies predicted federal revenues would fall by $330 billion over five years. Instead, they fell by $79 billion.

In both cases, taxpayers got higher post-tax incomes, expanded economic opportunities and better financial security. The government got a faster-growing economy, more people working, more taxable earnings per worker and, thus, more revenue than "static" estimates had predicted.
Yet "static" estimates still hold sway in Washington. Last year, they predicted President Bush's tax cut plan would cost $1.6 trillion, which is why Congress elected to "sunset" much of the cut by 2011. Reality-based (so-called "dynamic") estimates predicted a cost of slightly more than half that. We lost a chance to enact meaningful long-term tax reform because Washington's official cost estimates bore no resemblance to reality.

Indeed, these estimates bore no resemblance to how any privately owned business would handle the problem either. Would Chevrolet consider a price increase on Luminas without determining what it would lose in market share as a result? Would McDonald's double the price of the Big Mac without extensive study?

No. And why wouldn't they? Because businesses know what government ought to know -- that changes in taxes, prices or costs bring changes in the market, and to fail to consider those changes when it is possible to do so with reasonable accuracy is irresponsible.

And it's not like the present models can boast of infallibility. This year, for instance, federal budget analysts estimated the United States would finish with a $5 billion surplus. We were $122 billion in deficit through just the first nine months of the fiscal year, and that doesn't include Sept. 11 costs -- which no one could've predicted.

Economists can, and should, quibble over how much tax cuts change the fiscal picture, and even dynamic models must be updated as conditions change. But it's beyond argument that tax cuts generate economic activity and that any model for estimating costs that doesn't account for this ill serves the American people. "Static" scoring has proven to be a colossal failure, and it deserves to be retired.

William W. Beach is the director of Center for Data Analysis at The Heritage Foundation, a Washington-based public policy research institute.

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