February 26, 2015

February 26, 2015 | Commentary on Budget and Spending

News flash — Paul Ryan denies the Earth is flat

Over the past few weeks, Rep. Paul Ryan (R-Wis.) has come under attack in The New York Times, The Washington Post Wonkblog, the New Republic, U.S. News & World Report, Salon, Slate, and who knows where else for wanting congressional revenue forecasts to be based on "gimmicks," "tricks," and "voodoo," for wanting to "cook the books," for calling for "mischief" and for wanting the budget process to be "partisan."

His sin? He wants revenue estimates to reflect economic reality.

The optimal tax literature, the public finance literature, the economic growth literature and the price theory literature are very clear. Marginal tax rates and the tax treatment of investment have large "macroeconomic" effects on the economy. High marginal tax rates and tax policies that increase the cost of capital harm economic growth. Reducing high marginal tax rates and reducing the cost of capital improve economic growth. Historical examples in the U.S. and abroad abound. The current Joint Committee on Taxation revenue estimating methodology ignores these macroeconomic effects on work, savings, investment and output.

Ryan's detractors want to keep committing economic malpractice by ignoring the impact of tax policy on the economy. Ryan wants to take into account nearly a century of economic science when estimating the future tax revenues of the federal government. His detractors' arguments are as valid as the arguments of those who ignored reality and maintained that the earth was flat long after the facts were clear.

Reasonable people can disagree about the magnitude of the economic growth effects (although my reading of the evidence is that they are large). Moreover, it is cogent, though mistaken in my view, to argue that some social objective such as equalizing after-tax incomes or subsidizing alternative energy may justify the lost economic output, lost jobs and lower incomes that high marginal tax rates and a high cost of capital entail. But denying the economic reality of the adverse economic impact of current tax policy (called "deadweight loss" or "excess burden" in the economics literature) is not reasonable. It flies in the face of reality. Some argue that these estimates will be imprecise and should not be used. But it is better to have estimates that are approximately correct than those which are precisely wrong and known to be wrong.

Why does this seemingly technical argument matter? Proponents of existing tax policy and those who support even higher tax rates and even more punitive taxation of investment understand that the current methodology makes tax increases seem as if they will raise more revenue than they actually will. Similarly, current methodology makes tax rate reductions or improvements in the tax treatment of business investment seem as if they will reduce tax revenues more than they actually will. Current methodology makes tax reform that reduces marginal tax rates while appropriately broadening the tax base more difficult. Moreover, the current methodology does not distinguish between tax reductions that improve economic growth (marginal tax rate reductions and better treatment for business investment) and those that have little positive impact (child credits). Similarly, not all tax increases or tax base broadening are created equal. Broadening the tax base by eliminating unwarranted subsidies is one thing, while base broadening or tax increases that raise the cost of capital or discourage work, savings and investment have a substantial negative economic effect.

The bottom line is this: Calling for federal revenue estimates that take reality into account is not a gimmick or a trick or cooking the books. It is akin to acknowledging that the earth is a sphere and not flat. We should have done so long ago. Paul Ryan deserves commendation, not derision, for deciding to tackle this important institutional reform. It will remove an artificial barrier to tax policies that will renew prosperity and improve the lives of millions of Americans.

 - David Burton is senior fellow in economic policy at the Heritage Foundation

About the Author

David R. Burton Senior Fellow in Economic Policy
Thomas A. Roe Institute for Economic Policy Studies

Originally appeared in The Hill