May 3, 2002 | Executive Summary on Taxes
The debate between static and dynamic scoring may seem an esoteric inside-the-Beltway squabble, but the choice of how to estimate revenues has important implications. In the short term, better revenue estimating methods would make it easier to implement tax rate reductions. In the long term, shifting to a simple and fair tax code would be expedited if revenue estimators were allowed to consider the beneficial impact of tax reform on economic performance.
When lawmakers consider tax policy changes, Congress's Joint Committee on Taxation (JCT) and the Treasury Department's Office of Tax Analysis (OTA) are responsible for estimating the likely impact on future tax collections; but these estimates assume that tax policy changes--regardless of their magnitude--have no impact on the economy's performance. As a result, these "official" estimates commonly overstate both the amount of tax revenue that will be generated by tax increases and the amount of revenue the government will "lose" due to tax rate reductions. This static methodology has been widely criticized because it provides policymakers with inaccurate numbers and creates a bias against lower tax rates.
Dynamic analysis--sometimes referred to as reality-based scoring--is based on the commonsense assumption that taxes do affect the economy. Dynamic scoring recognizes, for instance, that higher tax rates discourage work, saving, and investment. Because of these negative "feedback effects," tax rate increases will generate less revenue than predicted by static estimates. Conversely, because lower tax rates increase economic growth and result in more jobs, higher wages, and bigger profits, dynamic scoring will show that certain tax cuts will be at least partially self-financing. This more accurate methodology should be used instead of static scoring.
Because dynamic scoring would make tax
rate reductions more attractive, opponents of tax cuts want to
maintain the current system of static scoring. An objective
examination of the historical evidence, however, demonstrates that
dynamic scoring gives policymakers more accurate information.
Dynamic scoring does not predetermine outcomes; it simply ensures that lawmakers will have the most comprehensive data when making decisions. When taking steps to modernize and correct the revenue-estimating process, policymakers should consider the following points:
To make America's economy more competitive and to boost the economy's performance, tax policy will have to change. In the short term, immediate tax rate reductions are needed to boost growth; in the long term, the entire tax code should be replaced by a simple, flat tax. But these pro-growth changes will be harder to achieve if revenue estimators continue to use outdated and inaccurate static models. Dynamic revenue estimates would provide policymakers with more accurate information. Dynamic forecasting is based on a proper understanding of how the economy works, and history has shown this approach to be far more realistic and accurate than static estimates.
Daniel J. Mitchell, Ph.D., is McKenna Senior Fellow in Political Economy in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.