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Regime Change in Scoring
Thursday, April 3, 2003
Six years ago, the House Policy Committee published a Policy Perspective entitled "Why Congress Needs Accurate Scoring of Tax Rate Reductions." Now, by considering the growth effects of tax rate reductions, the Congressional Budget Office has taken the most tangible step yet toward accurate estimating since the fall of the Democrat Congress in 1994. Accurate scoring is vital to the enactment of sound tax policy that will create jobs and grow the economy.
A Failed Model
On June 9, 1997, the Policy Committee released a Policy Perspective documenting the long history of error in calculating the revenue effects of changes in tax rates. By ignoring the effect of tax rate changes on the economy as a whole, Congressional revenue estimates have been rendered notoriously inaccurate. For example, capital gains tax rate adjustments in 1978, 1981, and 1986 were scored by the Joint Committee on Taxation using economic growth forecasts that were identical with or without the proposed change in tax policy. In each case, JCT’s forecast was 180 degrees wrong. Where JCT predicted lower tax revenue, revenue rose; where JCT predicted higher tax revenue, revenue fell.
Finally, in 1997, revenue forecasters took exceptionally modest notice of the fact that reducing the capital gains tax could raise revenue—but badly underestimated just how much. A JCT prediction issued the same day as 1997’s Policy Perspective forecast that capital gains tax revenue would rise in the first, second, and sixth years after the rate was reduced from 28% to 20%. In fact, capital gains revenue surged well beyond all expectations, growing more than 50% in the first three years after the rate was reduced, permanently elevating the economic baseline, and helping the federal government to pay down more than $450 billion in public debt.
The huge federal budget surpluses that resulted in part from this surge in capital gains tax revenue had a negative effect as well: they initiated a spending spree that contributed to the loss of market confidence. Combined with the costs of the war against terrorism, this loss of confidence has slowed economic growth. Today, as Congress considers new legislation to reinvigorate economic growth and create new and better-paying jobs, it is vital that tax policy choices be informed by more accurate revenue forecasting.
A First Step
For the first time, on March 25, 2003, empirical data derived from previous tax rate changes was used by CBO to estimate the effects of the President’s budget proposal on the American economy. This much-anticipated “dynamic” analysis estimates that economic growth, after adjusting for inflation, would be 1.3% higher next year if the President’s economic growth tax proposals are enacted. Moreover, unemployment would be reduced by a full point.
As a first attempt, CBO concedes that its analysis is far from perfect. Ironically, that concession goes far toward enhancing CBO’s credibility. CBO’s new presentation of how and why its numbers might vary makes it possible, for the first time, to appreciate the sensitivity of the forecast to various assumptions.
Budget Committee Chairman Jim Nussle, and Ways & Means Committee Chairman Bill Thomas, have already commended CBO’s effort, while pointing out ways that the analysis could be made even more useful. One shortcoming both identified was the fact that the growth-enhancing measures were lumped together with the growth-retarding measures. Chairman Nussle noted that the CBO report:
" ... is an analysis of the President’s entire budget, not just the President’s growth package. CBO examined all of the President’s policies—taxes and spending—to measure the effect all of those policies in sum would have on the economy. Although the economic growth package clearly generates positive economic outcomes, some of the policies in the President’s budget do not (e.g., tax credit for the uninsured), and some policies have a slight negative effect on the economy (persistent budget deficits). ... The President’s job creation package will help the economy and create jobs. CBO confirms what many private forecasters have said: that the President’s proposals would boost economic growth (real GDP) and employment in the near term. Unemployed workers would have jobs sooner, and workers would have higher incomes than without a proposal such as the President’s.
Meanwhile, Chairman Thomas notes:
"What CBO found is that smart tax relief, notably the President’s dividend proposal, has real economic benefits. CBO also found that spending increases and inefficient tax cuts have economic costs. The net effect to the economy is only negative because tax cuts are eclipsed by spending increases."
Conclusion
Republican economic policy is clear: to promote economic growth through lower taxes and fiscal responsibility. The empirical data derived from previous tax rate changes is finally being used to inform wise choices in tax policy that will help achieve economic growth. The CBO’s report, delivered to the House Budget Committee on March 25, 2003, is a refreshing change and a new beginning.
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