July 30, 2002 | Commentary on Federal Budget
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take effect in 2004 and 2006 … and are then repealed in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
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
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
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
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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