<DOC>
[109th Congress House Hearings]
[From the U.S. Government Printing Office via GPO Access]
[DOCID: f:29891.wais]
HOW BUDGETARY CHOICES AFFECT
WORK, SAVING, AND GROWTH: THE
REAL PURPOSE OF DYNAMIC ESTIMATING
=======================================================================
HEARING
before the
COMMITTEE ON THE BUDGET
HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
HEARING HELD IN WASHINGTON, DC, SEPTEMBER 13, 2006
__________
Serial No. 109-20
__________
Printed for the use of the Committee on the Budget
Available on the Internet:
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COMMITTEE ON THE BUDGET
JIM NUSSLE, Iowa, Chairman
JIM RYUN, Kansas JOHN M. SPRATT, Jr., South
ANDER CRENSHAW, Florida Carolina,
ADAM H. PUTNAM, Florida Ranking Minority Member
ROGER F. WICKER, Mississippi DENNIS MOORE, Kansas
KENNY C. HULSHOF, Missouri RICHARD E. NEAL, Massachusetts
JO BONNER, Alabama ROSA L. DeLAURO, Connecticut
SCOTT GARRETT, New Jersey CHET EDWARDS, Texas
J. GRESHAM BARRETT, South Carolina HAROLD E. FORD, Jr., Tennessee
THADDEUS G. McCOTTER, Michigan LOIS CAPPS, California
MARIO DIAZ-BALART, Florida BRIAN BAIRD, Washington
JEB HENSARLING, Texas JIM COOPER, Tennessee
DANIEL E. LUNGREN, California ARTUR DAVIS, Alabama
PETE SESSIONS, Texas WILLIAM J. JEFFERSON, Louisiana
PAUL RYAN, Wisconsin THOMAS H. ALLEN, Maine
MICHAEL K. SIMPSON, Idaho ED CASE, Hawaii
JEB BRADLEY, New Hampshire CYNTHIA McKINNEY, Georgia
PATRICK T. McHENRY, North Carolina HENRY CUELLAR, Texas
CONNIE MACK, Florida ALLYSON Y. SCHWARTZ, Pennsylvania
K. MICHAEL CONAWAY, Texas RON KIND, Wisconsin
CHRIS CHOCOLA, Indiana
JOHN CAMPBELL, California
Professional Staff
James T. Bates, Chief of Staff
Thomas S. Kahn, Minority Staff Director and Chief Counsel
C O N T E N T S
Page
Hearing held in Washington, DC, September 13, 2006............... 1
Statement of:
Hon. Ander Crenshaw, acting chairman, Committee on the Budget 1
Douglas J. Holtz-Eakin, director, Maurice R. Greenberg Center
for Geoeconomic Studies, Council on Foreign Relations...... 5
John W. Diamond, fellow in tax policy, James A. Baker III
Institute for Public Policy................................ 12
Leonard E. Burman, senior fellow, Urban Institute............ 17
Prepared statement of:
Mr. Crenshaw................................................. 3
Mr. Holtz-Eakin.............................................. 9
Mr. Diamond.................................................. 15
Mr. Burman................................................... 19
HOW BUDGETARY CHOICES AFFECT
WORK, SAVING, AND GROWTH: THE REAL
PURPOSE OF DYNAMIC ESTIMATING
----------
WEDNESDAY, SEPTEMBER 13, 2006
House of Representatives,
Committee on the Budget,
Washington, DC.
The committee met, pursuant to call, at 10:07 a.m. in room
210, Cannon House Office Building, Hon. Ander Crenshaw (acting
chairman of the committee) presiding.
Present: Representatives Crenshaw, Barrett, Chocola, Diaz-
Balaret, Wicker, Ryun, Putnam Neal, Baird, Cuellar, and Moore.
Mr. Crenshaw. The meeting will come to order. This is a
hearing on how budgetary choices affect work, savings, and
growth. I want to say welcome to our witnesses, and I will make
an opening statement, and then ask Mr. Neal to do the same.
When Congress writes the Federal budget each year, we rely
on a range of technical rules and conventions called budget
concepts that were designed to give us a stable and consistent
playing field for the policy decisions that we make. Because
these budget concepts set the rules not only for how we write
budgets, but also how we enforce them, I believe that it is
critical for this body to engage in a comprehensive review of
those rules to ensure that they are not only accurate but
current, relevant, and truly helpful for our legislative work.
While we have done some tweaking here and there over the
years, a comprehensive formal review has not been undertaken in
nearly 4 decades. Clearly, 40-year old concepts cannot possibly
account for the real word economic precepts that drive our 21st
century economy.
So last week I introduced legislation establishing a
commission of experts to review the technical underpinnings of
our budget and accounting practices to report the findings back
to Congress. This Commission will provide needed oversight and
make recommendations on ways to modernize our basic budgetary
principles as Congress brings more accountability and
transparency to the budget process while dealing with 21-
century issues.
This brings me to the subject of today's hearing, what is
known as dynamic analysis of budget policies, which is one of
the most important concepts to be studied under the bill that I
have proposed.
Dynamic estimating has been discussed and analyzed, and
even attempted, to some degree, since the Reagan
administration, and along the way it has attracted its share of
confusion, so let me take a moment to dispel two of the most
common misconceptions on the subject.
First of all, I think everyone understands that dynamic
analysis is not a means of showing that tax cuts pay for
themselves. Dynamic analysis does show how various pro-growth
policies, especially tax policies, affect people's incentives
to work, save and invest; and thus affect the economy's
performance. When these incentives are taken into account, they
can alter the pace of economic growth and, in turn, produce
additional revenue that might not have been expected without
the implemented policies.
The impact of our legislative actions must be analyzed to
produce a fair, accurate picture of the costs and benefits
associated with various tax policies. For instance, several
recent tax measures have had an impact on our overall tax
revenues, however, the true impact of these measures were not
captured, so to speak, in our original analysis of the
proposals. One example that comes to mind is the tax cuts that
were adopted by Congress in 1997. At that time, Congress cut
taxes by about $89 billion over 5 years, and yet tax revenues
the next year increased from 19.3 percent of GDP to 20 percent
of GDP and the budget was balanced.
Another example is that over the past 2 years, we have seen
double digit growth in revenues, and declining budget deficits,
even though we have stuck with the tax relief of 2001 and 2003.
These are historical facts demonstrating that cutting taxes and
increasing revenue are not necessarily contradictory if you can
reduce taxes in ways that enhance incentives for growth. So
dynamic analysis is a way of incorporating these economic
effects in our budget estimates.
The second point I want to make is that dynamic analysis
does not guarantee perfect accuracy in estimating budget
outcomes. First, budget estimating always involves making
assumptions about what will happen in the future, so there will
always be some level of uncertainty involved. Add that to the
fact that you are dealing with a $2.8 trillion budget in the
midst of a highly diverse $13 trillion market economy, and the
chances of getting absolute perfection in the budget estimates
are pretty slim.
The important benefit of dynamic analysis is that it helps
us see more clearly the real effects of our policy choices and
the ramifications they can have. It systematically examines how
policy affect incentives to work and invest, which directly
affect how people live their lives. For example, we might find
that two different policies with the same budget outcome
actually have very different incentive effects and therefore,
different effects on people's lives. Dynamic analysis can, so
call, feedback this information to see how the policy will
affect our economy overall.
I believe this is helpful information to have when we are
making important decisions, often expensive policy choices.
So now, budget analysts have already been looking into
these incentive effects for some time, but we have not pulled
together all the pieces of this comprehensive dynamic analysis
approach. How to go about doing that is one of the things our
witnesses will discuss today.
On a final note, today's hearing will focus mainly on
dynamic analysis. While we often hear the terms dynamic
analysis and dynamic scoring used interchangeably, they are not
necessarily the same. Dynamic scoring deals with a particular
application of dynamic analysis. The analysis is the broader
overarching concept and, again, what we will be focusing on
today.
To help us in this discussion, we have with us Dr. Douglas
J. Holtz-Eakin, former director of our Congressional Budget
Office (CBO), John W. Diamond, a tax policy expert at Rice
University who has worked directly on dynamic analysis for the
Treasury Department, and Leonard Burman, a senior fellow at the
Urban Institute.
Dynamic analysis is a particularly complicated subject and
employs a lot of specialized technical principles and language,
and we are fortunate to have these witnesses here today, not
only knowledgeable on the subject, but they are also very well
skilled at describing complicated issues to non economists such
as Members of Congress and other policymakers and the public.
So again, we welcome all three of you here today. Thank you for
being here.
And with that I will turn to Mr. Neal for any opening
statement that he may have.
[The prepared statement of Mr. Crenshaw follows:]
Prepared Statement of Hon. Ander Crenshaw, a Representative in Congress
From the State of Florida
When Congress writes the Federal budget each year, we rely on a
range of technical rules and conventions--called budget ``concepts''--
that were designed to give us a stable and consistent playing field for
the policy decisions we make.
Because these budget concepts set the rules not only for how we
write budgets, but also how we enforce them, I believe that it is
critical for this body to engage in a comprehensive review of those
rules to ensure that they're not only accurate, but current, relevant,
and truly helpful for our legislative work. While we have done some
tweaking here and there over the years, a comprehensive, formal review
of our technical rules has not been undertaken in nearly four decades.
Clearly, forty year old concepts cannot possibly account for some of
the real-world economic precepts that drive our 21st Century economy.
So, last week I introduced legislation establishing a commission of
experts to review the technical underpinnings of our budget and
accounting practices and report its findings back to Congress. This
commission will provide needed oversight and make recommendations on
ways to modernize our basic budgetary principles as Congress brings
more accountability and transparency to the budget process while
dealing with 21st Century issues.
This brings me to the subject of today's hearing--what's known as
``dynamic'' analysis of budget policies--which is one of the most
important concepts to be studied under the bill I've proposed. Dynamic
estimating has been discussed and analyzed--and even attempted, to some
degree--since the Reagan administration. And along the way, it has
attracted its share of confusion. So let me take a moment to dispel two
of the most common misconceptions on the subject.
First, I think everyone understands that dynamic analysis is not a
means of showing that ``tax cuts pay for themselves.'' Dynamic analysis
does show how various pro-growth policies--especially tax policies--
affect people's incentives to work, save, and invest--and thus, affect
the economy's performance. When these incentives are taken into
account, they can alter the pace of economic growth, and in turn
produce additional tax revenue that might not have been expected
without the implemented policies. The impact of our legislative actions
must be analyzed to produce a fair, accurate picture of the costs or
benefits associated with various tax policies.
For instance, several recent tax measures have had an impact on our
overall tax revenues; however, the true impacts of those measures were
not ``captured'' in our original analysis of the proposals. One example
that comes to mind is the 1997 tax cuts adopted by Congress. At that
time, Congress cut taxes by about $89 billion over five years--and yet
tax revenue the next year increased from 19.3% of GDP to 20%, and the
budget was balanced.
Another example is that over the past two years, we've seen double-
digit growth in revenue--and declining budget deficits--even though
we've stuck with the tax relief of 2001 and 2003. These are historical
facts, demonstrating that cutting taxes and increasing revenue are not
contradictory--if you can reduce taxes in ways that enhance incentives
for growth.
Dynamic analysis is a way of incorporating these economic effects
in our budget estimates.
Second, dynamic analysis does not guarantee perfect accuracy in
estimating budget outcomes. But nothing could. First, budget estimating
always involves making assumptions about what will happen in the
future--so there will always be some level of uncertainty involved. Add
to that the fact that you're dealing with a $2.8-trillion budget in the
midst of a highly diverse, $13-trillion market economy, and the chances
of getting absolute precision in budget estimates are slim.
The important benefit of dynamic analysis is that it helps us see
more clearly the real effects of our policy choices, and the
ramifications they can have. It systematically examines how policies
affect incentives to work and invest--which directly affect how real
people live.
For example, we might find that two different policies with the
same budget outcomes actually have very different incentive effects--
and therefore different effects on people's lives. Dynamic analysis can
``feed back'' this information to see how the policy will affect the
economy overall. I believe that's helpful information to have when
we're making important and often expensive policy choices.
Now, budget analysts have already been looking into these incentive
effects for some time. But we've not pulled together all the pieces for
a comprehensive dynamic analysis approach. How to go about doing this
is one of the things our witnesses will discuss today.
On a final note--today's hearing will focus mainly on dynamic
analysis. And while we often hear the terms ``dynamic analysis'' and
``dynamic scoring'' used interchangeably--they are not the same.
``Dynamic scoring'' deals with a particular application of ``dynamic
analysis.'' The analysis is the broader, overarching concept, and
again, what we'll be focusing on today.
To help us in this discussion, we have with us Dr. Douglas J.
Holtz-Eakin, former director of our Congressional Budget Office; John
W. Diamond, a tax policy expert at Rice University who has worked
directly on dynamic analysis for the Treasury Department; and Leonard
E. Burman, a senior fellow at the Urban Institute.
Dynamic analysis is a particularly complicated subject, and employs
a lot of specialized, technical principles and language. We are
fortunate to have witnesses today who are not only very knowledgeable
about the subject, but who are also skillful at describing complicated
issues to non-economists--such as Members of Congress, other policy
makers, and the public.
So again, welcome to all three of you, and thank you for being with
us today.
With that, I'll turn to Mr. Spratt for any opening statement he may
have. Mr. Spratt?
Mr. Neal. Thank you very much, Mr. Chairman. I am sitting
in for Mr. Spratt this morning, and I want to say a word of
welcome to our witnesses as well.
This really should be called the dynamic deficits hearing.
I think that is a more accurate portrayal of why we are here.
The subject of how best to accurately estimate the budgetary
impact of various policy proposals is certainly important,
especially at a time when the Federal budget faces enormous and
persistent deficits. There is a natural tendency to hope that
the tax cuts cost less than they might first seem to. There are
still a number of unanswered questions about dynamic analysis,
and the hearing today should provide us with additional insight
into those questions.
However, it is worth noting that there is a strong
consensus among mainstream economists on a few key points.
First, dynamic estimation is dependent on the economic
assumptions in different models. So whether a particular
policies macroeconomic impact is estimated to be positive or
negative often hinges on the underlying assumptions of the
model.
Second, whether a policy's economic effects are estimated
to be positive or negative, these effects are generally
estimated to be relatively small. For example, a recent
Treasury Department analysis shows a range of possible economic
effects for making permanent the President's tax cuts. But the
most optimistic outcome included in the analysis shows the
economy growing by only a few hundredths of a percentage point
in extra economic growth per year.
Third, though we all wish for policies that magically pay
for themselves, the economic effects estimated by dynamic
analysis are sufficiently modest that they are relatively close
to the current estimates produced by the Joint Committee on
Taxation (JCT). Claims that tax cuts produce more revenue and
therefore, improve the budget's bottom line are not supported
by economic research or by a stream of revenues collected by
the Treasury.
Fourth, all long-term dynamic estimates assume that there
is some sort of offset to compensate for the cost of tax cuts.
But the current administration has not proposed offsets for its
policies, choosing instead to finance them with new borrowing
and new debt, including fighting two wars with seven tax cuts.
There are a lot of technical issues that I think are worth
reviewing as they surround this process, and I hope that
today's hearing can be a worthwhile part of a larger discussion
of the benefits and pitfalls of dynamic scoring.
We all want a scoring process that provides as much
information as possible about the economic effects of fiscal
policy. But we also want a policy that is accurate, unbiased
and timely. I hope that as we begin this discussion, we are not
going to start from the premise that deficits are not really
deficits. I hope that as we proceed with earmark reform here,
and yesterday's news accounts indicated where many of our
colleagues are on earmark reform, they are for it, but they
want help in stopping them before they spend again.
And some of the loudest voices for fiscal responsibility
around here, I noted, with news accounts over the last couple
of days, really are among the bigger spenders in Congress as it
relates to the whole notion of loading up the appropriations
bills. All we need in that instance is the line-item veto to
stop them from spending again.
So I have great regard for our witnesses, and I hope that
those shed some light on a very timely topic. But I hope that
we will not find our way into a situation whereby the simple
argument is that if we change the way we talk about these
issues, somehow the issues will resolve themselves.
Thank you, Mr. Chairman.
STATEMENTS OF DOUGLAS J. HOLTZ-EAKIN, DIRECTOR, MAURICE R.
GREENBERG CENTER FOR GEOECONOMIC STUDIES, COUNCIL ON FOREIGN
RELATIONS; JOHN W. DIAM0ND, FELLOW IN TAX POLICY JAMES A BAKER
III INSTITUTE FOR PUBLIC POLICY; AND LEONARD E. BURMAN, SENIOR
FELLOW, URBAN INSTITUTE
Mr. Crenshaw. Thank you very much. We will start with our
witnesses now, and first I will call on Dr. Holtz-Eakin.
STATEMENT OF DOUGLAS J. HOLTZ-EAKIN
Mr. Holtz-Eakin. Thank you, Chairman Crenshaw and Ranking
Member Neal, members of the committee, it is a pleasure to be
here today. This is, in fact, a very important issue, the
nature by which the scoring is done for proposals presented to
the Congress, and I would want to applaud the chairman's
efforts to lay out the language clearly at the beginning, but
in order to make sure that I am clear about the things that I
say, let me provide my own definitions as I see them.
You can put several words after dynamic. One, you could say
dynamic analysis, and I think of a dynamic analysis as one-time
efforts to look at the impact of, in particular, fiscal
policies on the overall macroeconomic performance of the
economy.
You could also put after it dynamic estimating, which I
think of as one time efforts to extend a dynamic analysis to
include the specific feedbacks on tax and spending in the
Federal budget, and thereby alter the estimates of the
budgetary future.
Or you could use the word dynamic scoring, and that, I
think, is a bigger step yet, one which involves the regular and
systematic estimating of the impact of the legislation on the
unified budget by including macroeconomic feedbacks. And in
going to that step, I would emphasize the regular part of it,
and the fact that it would be incorporated into the official
scoring process used by the Congress. And I want to focus my
remarks today on the kinds of issues that arise if one thinks
of doing this in a more regular fashion.
It is quite straightforward for many analysts to do one-
time analyses of different fiscal policies, and the academic
think tank and larger community has done many such things over
time. I think the important issue for this committee is
regularizing the process and providing information on a
comparative basis for many different proposals, and I want to
focus on that.
Before doing that, I want to really emphasize that the
notion of dynamic versus static has really led to an
unfortunate misperception of what static scoring or the current
conventions really means. It has led some people to believe
that the current scoring process essentially envisions that
every U.S. household and every U.S. firm and every U.S.
economic actor is frozen in some sort of ice freeze and doesn't
react to fiscal policy. That is just not true. If you think of
the Medicare Modernization Act, for example, this was the
creation of an entity that did not exist in nature, a privately
provided insurance benefit for the cost of outpatient
prescription drugs.
In doing that estimate, analysts had to imagine what firms
would enter such a market, what beneficiaries would take up
such coverage, what bids firms would makes to cover those
particular retirees, what firms would drop their current
retiree coverage, and how individuals would react to the loss
of their Medigap coverage and, in the end, how much the Federal
Government would have to pick up in terms of the cost of that.
There is an extraordinary range of economic behaviors and
responses included in that estimate which is labeled static
under the conventional language, and so I want to really
disabuse everyone of the notion that somehow the current
process does not include economic behavior and responses to
incentive. There is a lot in there. It is true at the CBO, and
it is true at JCT.
What dynamic scoring would do would be to extend the
boundary of those behaviors to allow the current practice of
fixing the total economic activity as it is in the baseline
provided and allow it to be extended to let fiscal policy raise
the level of economic growth or lower the level of economic
growth, and thereby change total incomes and total output in
the economy. That is the essential step taken by dynamic
scoring, and I think it would be desirable to do that in
principle.
Certainly, when one evaluates policies, you like to look at
the world without the policy, look at the world with the policy
and compare all the feedbacks in between, including those which
raise and lower economic growth. And in the current
environment, understanding policies which are superior for
long-term economic growth is very important. There are
tremendous demands that will face this economy as the baby
boomer retires and as we deal with the costs of Social
Security, Medicare, Medicaid and a litany of other demands,
with which you are very familiar.
So a premium should be placed on policies which actually
support long-term economic growth because that is the economic
pie out of which all of these demands will be met. And in doing
that, it will be important to recognize that not all spending
programs are created the same. Not all tax cuts are created the
same, and that doing a dynamic scoring exercise can
differentiate between them.
The difficulty, of course, is turning this into a regular
practice, and in my testimony, I laid out some of the issues,
and I want to touch briefly on them in sort of highlighting
what it would take to turn this into a regular part of the
process. The first is just the fact that it is a larger
enterprise. To undertake a full dynamic analysis is essentially
to undertake two baseline forecasting exercises. The production
of the baseline budget outlook is a very large enterprise at
the CBO, the JCT and the Budget Committees. To do it on a more
regular basis would involve a greater scale of activity. And
sadly, most of that activity would happen at very bad times
from the point of view of analysts. It is often the case that
in legislative deliberations important changes are made at
night, on weekends, as the Congress comes to terms with exactly
the final form of a proposal, and those legislative changes
often matter. The language does matter. We have all been
through experiences like that. So having that interact with the
need for a lot of time to do the dynamics, I think, highlights
a potential problem with doing this too frequently, that it
will be hard to get it done.
The second issue that comes up all the time is that
currently, lots of dynamic estimating, dynamic analyses use
different models, and it would be necessary in a formal budget
process, to come up with a single set of numbers. The Budget
Committee would have the responsibility for blessing the budget
estimates, and there would be a single set of such estimates
attached to each legislation. And so that raises the question
of just how that acceptance will take place. I don't think that
is insurmountable, but it is work that needs to be done. There
has to be some agreement about the nature of the modeling.
In similar spirit, there will have to be some agreement on
what to do with the issue of offsetting policies outside the
budget window. As the Treasury report has made quite clear, if
you imagine having a tax cut now which requires some offsetting
policy in the future, you get a very different answer if you
assume that we are going to raise taxes in the future, versus
if we are going to cut government consumption in the future.
Now, scoring is the art of ranking alternative proposals.
And if you think of scoring as just a ranking issue, better
proposals will look better on either offsetting policy, they
will look better even if you raise taxes in the future, they
will look especially better if you cut spending in the future.
The key is to have an agreed upon policy outside the budget
window that will apply to all proposals so that the rankings
are not altered by what policies are assumed at the outset. So
you have to have some assumption about the nature of the
offsetting policy.
I think it is also important to reach agreements in doing
this on what kinds of growth will be incorporated into dynamic
scoring. In the midst of a recession, if the Federal Government
chooses to cut taxes, increase spending or, in other ways,
throw money at the private sector, it is quite likely to
produce the kind of growth that comes from using existing labor
and capital that is currently unused. That is not the recipe
for long run growth. That is actually typically at odds with
the recipe for long run growth.
So I think it would be important to focus the kinds of
growth rewarded in dynamic scoring on long run growth, not on
cyclical recoveries, and that would be an agreement that would
have to be reached, and those who use the dynamic scoring,
which kinds of feedbacks would be agreed upon.
And then finally, at the moment, two different entities are
involved in the scoring process. The Joint Committee has
primary responsibility for taxes. The CBO has primary
responsibility for spending. The essence of a dynamic analysis
is that, regardless of where the impetus begins, on the
spending side or the tax side, you want to keep track of the
ultimate impact on both sides of the Federal budget, feedbacks
on tax receipts, feedbacks on spending, net impact on the
unified budget. That will require greater coordination between
those two bodies in doing this kind of work, and that is an
issue that the Budget Committee should be quite focused on in
thinking about moving forward.
So I think this is a sensible piece of science. I think it
is the kind of information that you would want to have in the
scoring process. I think there are some important logistical
and essentially scoring conventions that need to be established
in order to move forward. And if that were to be accomplished,
it is important to recognize that this will not be a panacea in
many ways. It will not, in fact, improve the accuracy, as was
noted at the outset.
Scoring is not about accurate projection. It is about
accurate ranking of alternative proposals, which ones have
bigger and smaller effects on the Federal deficit, not what
will the actual number be. And for that reason, we do scoring
now off a fixed baseline and using a unified set of rules.
Dynamic scoring should be done off a fixed baseline using a
unified set of rules. It isn't about forecasting the future,
about ranking alternative proposals. It won't relieve analysts
of judgment calls.
Dynamic scoring is not a box into which you drop a proposal
and out comes the magic answer. It will have more judgment
calls than were true in the past, but I don't think that should
be a disqualifying factor. It is simply a fact of life that
there are many things about which we know a lot, and there are
many things about which we know very little. And that is not a
dynamic scoring issue. That is a scoring issue. In the current
setting there are lots of proposals that come through about
which we know very little, and judgment calls are necessary.
The same will be true in dynamic scoring as well.
And finally, I don't think it would change the world very
much. There aren't many proposals that the Congress considers
which have such profound impact that it will alter the course
of the economy in a substantial way. And so the idea that
somehow moving to dynamic scoring would change budgets
estimates in a big way on a regular basis, I think, is
overblown.
I include in my testimony the observation that if you went
back to 1820, the world's economic power was the United
Kingdom. And from that point to the present the United States
grew about four-tenths of a percent faster than Great Britain
on average over that period, four-tenths of a percent. That
completely revolutionized the economic standing of both
countries in the world, which is a big impact.
To make the United States the world's economic super power,
but it was four-tenths of a percent. So four-tenths is big, and
I doubt there are many proposals as big as changing the
standing of those two countries in the world economic order. So
I don't think you will get big impacts out of this.
But I look forward to the chance to answer your questions,
and I thank you for the opportunity to be here today.
Mr. Crenshaw. Thank you very much.
[The prepared statement of Douglas Holtz-Eakin follows:]
Prepared Statement of Douglas J. Holtz-Eakin, Director, Maurice R.
Greenberg Center for Geoeconomic Studies, Council on Foreign Relations
Chairman Nussle, Ranking Member Spratt and members of the
Committee, I am pleased to have the opportunity to discuss the topic of
dynamic scoring in the federal budget process. In my remarks, I wish to
make observations that fall into three broad areas:
<bullet> The principle of dynamic scoring is good science that
would potentially bring into the budget process greater information
regarding beneficial economic policies,
<bullet> Dynamic scoring faces difficulties of implementation in
the budget process, and
<bullet> Dynamic scoring is not a panacea for either policymaking
or the budget process.
Let me cover each in turn before taking your questions.
DYNAMIC SCORING IS GOOD SCIENCE
Budget ``scores'' are estimates of the change in the federal
unified budget that would result from the passage of specific statutory
language. All proposals are measured relative to a single, fixed
baseline outlook for the budget which is, in turn, built upon a
projection for the United States economy. A key feature of current
scoring is that in evaluating legislation, the aggregate amount of
economic activity--total production and income--is assumed to be
unchanged from its baseline values.
It is this feature that has led some observers to refer to current
scoring procedures as ``static.'' Unfortunately, this label has caused
certain critics to mistakenly conclude that current procedures do not
recognize the incentive effects of legislation--that firms, workers,
investors, and households continue their economic lives as if nothing
had changed. Nothing could be further from the truth. For example, in
scoring the impact of the Medicare Modernization Act (MMA),
congressional analysts necessarily had to incorporate the decision of
firms to offer insurance contracts for the cost of outpatient
pharmaceuticals and bid for customers, the willingness of seniors to
purchase such insurance, changes in the amount of drugs prescribed and
purchased, take-up of low-income subsidies, and a myriad other
decisions by households, firms, and governments. However, in keeping
with current practice, the overall level of gross domestic product and
national income was assumed to be unchanged.
Dynamic scoring would expand the range of economic impacts to
include the pace of economic growth--that is, estimating the change in
the aggregate level of economic output and income. This has some
desirable features. In estimating the impact of the legislation,
analysts would (a) consider the direct impacts on program costs and tax
receipts; (b) evaluate the effects on incentives to work, save, invest
and conduct economic affairs; (c) estimate the resulting change in the
overall level of economic activity; (d) compute the impact of this
higher or lower level of economic activity on program costs and tax
receipts; and (e) calculate the net impact of the legislation on the
unified budget. The key difference is step (d), which is in turn built
upon (c).
A virtue of dynamic scoring is that it extends analysis of budget
policy to include economic policy dimensions. Specifically, dynamic
scoring requires that analysts incorporate into their evaluation of
legislation all the economic feedbacks at the individual, household,
firm, and national level. For this reason, it has the potential to
distinguish between those policies which are equal in their budget
cost, but very different in their economic incentives. Indeed, one of
the most attractive aspects of dynamic scoring is its promise of
allowing policymakers to distinguish between economically efficient tax
and spending policies that promote growth, and those that work to
reduce the living standards of future generations.
DIFFICULTIES IN THE PRACTICE OF DYNAMIC SCORING
The mechanics of doing dynamic scoring are not new. Indeed, a
dynamic score can be thought of as the difference between two full-
blown baseline budget projections: one in the absence of the
legislation, and one in the presence of the proposed legislation. But
the scale of the analysis involved in preparing baseline budget
projections points to the first problem with wholesale adoption of
dynamic scoring: time. In many, if not most, instances statutory
language continues to evolve throughout the legislative process:
committee deliberation and reporting, floor amendments and votes, and
conference committee negotiations. Often there is a need for very quick
and timely scoring information. The scale of a dynamic scoring effort
may be in conflict with this need.
A second practical difficulty with dynamic scoring is the need for
a single, consensus estimate. The attraction of dynamic scoring is its
ability to reveal the impact of legislation on economic growth.
However, this impact depends crucially on the overall foresightedness
of U.S. households and firms. To take an extreme case, imagine
legislation that cuts all marginal tax rates by five percentage points,
with the cut to take effect five years from now, but sunset ten years
in the future. If people are extremely myopic, this policy has no
impact on incentives to work, save or invest and there is no dynamic
feedback. If they are moderately forward-looking, they may anticipate
lower taxes and respond to these incentives. If they are even more
forward-looking, they will recognize both the tax reduction and the
subsequent rise. As a result, they will work especially hard during the
intervening years--yielding a larger increase in output, incomes, and
taxes--with a sharper decline when taxes rise again.
One approach to this problem, exemplified by the Congressional
Budget Offices macroeconomic analysis of the president's budget
proposals, is to provide a variety of estimates, each corresponding to
a different degree of foresight. However, the budget scoring process
would require a single set of estimates, implying that a consensus be
reached on a wide variety of issues of this type: foresightedness, the
pace of international capital flows, saving responses of households and
firms, and so forth.
The example sketched above highlights another issue in the conduct
of dynamic scoring: the need for a standard ``offsetting policy.'' Over
the long-term, if individuals have foresight then government debt
(relative to the economy) must stabilize. Legislative proposals that
upset this requirement by increasing spending or reducing taxes (at
least relative to their impact on economic growth) will produce debt
that will grow explosively. Similarly, spending cuts or tax increases
(relative to their impact on the economy) will cause debt to spiral
down. Since the government can neither borrow nor save unboundedly
large amounts, it is necessary to put a stop to either spiral by
introducing an offsetting budget policy at some point in the future.
The choice of policy--spending increases or decreases and the pace
at which they take place, tax reductions or increases and their timing,
or some combination of these--will affect the behavior of individuals
and firms and influence the score. Since a primary objective of scoring
is to treat all legislative proposals equally, it will be necessary to
pick a single type of offsetting policy and use it for all proposals.
Another challenge in implementing dynamic scoring is the degree to
which the score reflects only supply-side growth, or also includes
demand-side cyclical influences. Broadly speaking, economies grow in
one of two ways. Supply-side growth occurs when there is an increase in
the capacity to produce goods and services though the addition of
greater labor supply (labor force participation, hours worked, higher
effort per hour, greater skills per worker, better efficiency in the
use of labor effort and skills, and so forth), greater physical capital
(more or better equipment, software, buildings, and so forth) and
improved technical prowess (new technologies or superior organization
and management).
Demand-side growth (or contraction) reflects business cycle
fluctuations in the extent to which existing labor supply, capital, and
technical prowess are utilized. The attention paid to monetary and
other stabilization policies is clear tribute to the fact that
recessions are costly and faster recoveries are desirable. But these
changes are transitory and it may not be desirable to include
transitory components in the budgetary evaluation of legislative
changes.
If these effects are included, they will depend crucially on
whether the budget baseline projection begins in a period of recession
or boom. If it is the former, then positive demand effects will augment
growth. If it is the latter, growth is limited and the result will be
faster onset of return to supply-side potential and greater
inflationary pressures.
Finally, the ultimate size, direction, and character of demand-side
effects depend as well upon the assumed path of monetary policy. In a
manner similar to offsetting budget policies, it would be necessary to
make assumptions regarding the response of monetary policy to the
legislative changes.
A final issue that arises in full-blown use of dynamic scoring is
the interaction between taxes and spending. At present, the
Congressional Budget Office scores spending proposals and the Joint
Committee on Taxation scores the bulk of tax legislation. By its
nature, dynamic scoring seeks to identify the indirect spending
consequences of tax legislation and vice versa. Accordingly, it will be
necessary for these groups to coordinate extensively their respective
efforts.
DYNAMIC SCORING IS NOT A PANACEA
One occasionally hears that dynamic scoring is desirable because it
will be more accurate. While dynamic scoring will more fully
incorporate a wider range of behavioral responses, it is not likely to
improve accuracy. First, the mechanical nature of scoring--evaluating
different policy proposals using a baseline fixed at the beginning of
the legislative calendar--is necessary for even-handed evaluation of
alternative proposals, but hardly a recipe for improved accuracy in an
ever-changing economy. Further, as noted earlier, the same level,
legislative playing field necessarily entails identical and
``unrealistic'' assumptions regarding offsetting budget policies and
monetary policy. Finally, to the extent that the pursuit of good policy
leads to a decision to focus on long-run, supply-side growth then the
elimination of cycles moves scoring even further away from ``accurate''
predictions.
Similarly, any move to dynamic scoring would not eliminate the need
for analysts making judgment decisions. Quite the contrary, as noted
above, in addition to the plethora of issues that already exist (e.g.,
how fast will legislation become law; how quickly will administrative
rule-making be completed; what will implementing regulation look like;
how fast will awareness spread and program participation rise?)
additional decisions will be needed on the nature of economic growth
policies' ability to influence it.
Neither of these outcomes is bad. The combination of baseline
projections and budget scores is intended to support the legislative
process, not forecast the economy. There are far more parsimonious and
accurate forecasting procedures available. Evaluating innovative
legislative proposals necessarily requires analytic judgment because
there is literally no policy track record on which to rely. Dynamic
scoring may reflect a change in the desired content of the budget
process; it does not change the fact that scoring supports that
process.
Finally, the greatest reason that dynamic scoring is not a panacea
is that it is unlikely to change the bottom line very much. The entire
federal budget is only one-fifth the U.S. economy, and few legislative
proposals affect even a fraction of the outlay or receipts stream. That
is, most legislative proposals don't have enough overall ``bang'' to
generate much dynamics. Of course, some have superior incentive
effects--a big ``bang for the buck.'' But even the dynamics of these
proposals are not likely to look very large. Over the period from 1820
to 1998, output per capita in the United States grew an average of 0.4
percentage points faster than in the United Kingdom (1.74 versus 1.35
percent per year). Thus, 0.4 percentage points per year--which
transformed the global economic order--is a big supply-side growth-
effect.
For this reason, some have proposed restricting dynamic scoring to
particularly comprehensive tax or spending proposals such as tax or
social security reform. While sensible in itself, taken at face value
it would produce an asymmetry between proposals evaluated with
traditional scoring and those that were evaluated using dynamic
scoring.
CONCLUSION
Mr. Chairman and members of the Committee, dynamic scoring is an
important and potentially valuable tool for Congress to use in
evaluating legislative proposals. I am grateful to have the opportunity
to discuss my views on the issue, and look forward to answering your
questions.
Mr. Crenshaw. Mr. Diamond.
STATEMENT OF JOHN W. DIAMOND
Mr. Diamond. Let me start by saying that my testimony is a
reflection of my views alone and should not be attributed to
any institution or agency that I am affiliated with in other
ways.
Chairman Crenshaw, Ranking Member Neal, and members of the
committee, it is an honor to testify before you on the
potential usefulness of including estimates of the
macroeconomic effects of tax and expenditure policies in the
budget process.
Dynamic scoring is theoretically preferred to the current
budget scoring process. However, many questions remain about
how best to implement a practical and timely framework for such
a method. In my testimony, I propose that it is more reasonable
to begin by focusing on consistent and timely use of dynamic
analysis in the budget process, rather than adopting dynamic
scoring initially for the following reasons: Dynamic analysis,
if used appropriately, can provide useful information about the
efficiencies and distributional effects of alternative tax
proposals.
Dynamic analysis is far less controversial than dynamic
scoring. And dynamic analysis is a necessary component in any
budget process that includes dynamic scoring because it would
be used to analyze and relay information about the
macroeconomic effects of tax proposals, which are not currently
included in conventional revenue estimates.
Implementing a budget process that encourages the adoption
of efficient, fair and simple tax and spending policies is
critical, given the fiscal gap facing our Nation. It is
important to note that dynamic analysis is already used on a
limited scale. For example, CBO and JCT have produced dynamic
analyses of several significant tax proposals.
More recently, the Department of the Treasury's Office of
Tax Analysis has published a dynamic analyses of the reform
proposals made by the President's advisory panel on Federal tax
reform, and the proposal to permanently extend the President's
tax relief.
A useful example is this latest Office of Technical
Assistance (OTA) report in July of 2006 that examines dynamic
effects of the President's proposal to permanently extend a
variety of tax provisions enacted in 2001 and 2003. The report
provides information on the macroeconomic effects of various
provisions as well as the aggregate effects of all of the
provisions. This information allows for a comparison of the
macroeconomic effects of various policies and, if used
appropriately, could prove useful in structuring an efficient
tax policy.
For example, the OTA report showed that lowering capital
gains and dividend taxes, coupled with a decrease in government
consumption after 10 years, increased gross national product by
0.4 percent in the long run. By comparison, if revenue losses
were offset by an across-the-board tax increase after 10 years,
the report predicts a 0.3 percent increase in real GNP in the
long run.
In fact, permanently extending the dividend and capital
gains tax cuts increased real GNP in the long run all of the
options considered in the OTA analysis. However, as noted by
OTA, changes in a variety of simplifying assumptions about the
underlying economic model or things that were excluded from the
model could strengthen or weaken these results.
For the base case parameter values in the report, the
report showed that permanently extending the cuts in the top
four ordinary income tax brackets, plus the repeal of the
phaseout of personal deductions and itemized deductions,
increases real GNP by 0.7 percent in the long run if the tax
cuts are offset by a decrease in government consumption after
10 years.
If the tax cuts are financed by an across-the-board tax
increase after 10 years, the policy has a negligible impact on
real GNP, so there is basically no growth effect. By
comparison, permanently extending the increase in the child
credit, the increase in the marriage penalty relief, and the 10
percent rate bracket reduces real GNP by 0.4 percent if
financed with government consumption after 10 years, and by 1.2
percent if financed by an increase in taxes.
Purely from an efficiency perspective, a permanent
reduction in dividend and capital gains tax rates is preferred
to lowering the four highest ordinary income tax rates, coupled
with the repeal of PEP and PEASE. Similarly, a permanent
reduction in dividend and capital gains tax rates, or the
changes to the top four income brackets, are preferred to an
increase in the child credit, the marriage tax relief, and the
10 percent rate bracket, as the latter are inframarginal
changes for most individuals.
However, efficiency is not the only important factor in
determining fiscal policy, and I think it is important to
recognize that fairness and simplicity in administration and
compliance must also be considered.
House rule 13 is a good starting point for implementing
dynamic analysis. But it could be improved. In particular, I
offer the following guidelines for implementing dynamic
analysis into the policy process. While examining the
macroeconomic effects of various proposals is of interest, this
approach ignores much of the additional information that could
be gleaned from dynamic analyses. Thus, dynamic analysis should
focus on comparing the macroeconomic effects of competing
provisions within a larger proposal and present the effect of
the total proposal as well.
Obviously, analyzing every provision separately would be
impossible and counterproductive as this would consume far too
many staff resources. However, it is important to insure that
the choice of provisions to be analyzed is not politically
driven as this would undermine the integrity of the process. A
balance must be struck on this issue.
Dynamic analysis should also be applied to spending
proposals, as the dynamic implications of expenditure policies
may be as important as those of tax policies, whether they be
positive or negative. Debt service costs are generally included
in dynamic analysis, but are not included in conventional cost
or revenue estimates. To be consistent, the debt servicing cost
of conventionally estimated policies should also be considered,
but not necessarily included in the official estimate, in the
policymaking decision. Otherwise, the budget process may be
biased toward proposals with negligible or negative long run
effects relative to proposals that increase long run growth.
Macroeconomics are not the only source of information that
should be provided to policymakers. Some measure of economic
well-being should also be provided in addition to macroeconomic
aggregates. This is important because positive macroeconomic
effects are not always associated with welfare gains.
Distributional analysis should also be conducted both
within income groups and across generational groups. For
example, the President's advisory panel on Federal tax reform
in the United States decided against recommending a true
consumption-based tax and instead proposed a consumption based
system supplemented with an add-on capital income tax at the
individual level. Given that the report showed that the
economic gains were larger under the consumption based tax
relative to the growth and investment tax, which was the
consumption based tax with the add on capital income tax, and
that the transitional effects of the two proposals were
different, it would be interesting to compare how the plans
differed from a distributional perspective, both during the
transition and in the long run and both across income groups as
well as across generations.
The extent of uncertainty contained in the dynamic analysis
should be well noted. We have gone over these issues many
times. But this includes issues like the sensitivity of the
results to various parameter values, the assumptions underlying
the economic model, whether the policy was financed by changes
in government spending, taxes, or government debt, and
assumptions about the reactions of other entities such as the
Federal Reserve, State governments and foreign countries.
Dynamic analysis should be timely so that it can be used
effectively in the policymaking process. If it is done too late
in the process, then it is not going to have an effect on
policymaking. But it is important to note, as Dr. Holtz-Eakin
has pointed out, that there are logistical constraints on this
issue that have to be considered.
Finally, I will just say that public disclosure is
imperative. As much information as possible should be released
to the public so that others can replicate the work of these
institutions.
Mr. Chairman and members of the committee, I am grateful
for the opportunity to discuss my views on this important
issue, and I look forward to answering your questions.
Mr. Crenshaw. Thank you very much.
[The prepared statement of John Diamond follows:]
Prepared Statement of John W. Diamond, Fellow in Tax Policy, James A.
Baker III Institute for Public Policy
INTRODUCTION
Chairman Nussle, Ranking Member Spratt, and Members of the
Committee, it is an honor to testify before you on the potential
usefulness of including estimates of the macroeconomic effects of tax
and expenditure policies in the budget process. Dynamic scoring is
theoretically preferred to the current budget scoring process; however,
many questions remain about how best to implement a consistent and
practical framework that allows macroeconomic effects to be included in
the budget process. In my testimony, I propose that it is more
reasonable to begin by focusing on consistent and timely use of dynamic
analysis in the budget process, rather than adopting dynamic scoring
initially, for the following reasons:
<bullet> Dynamic analysis, if used appropriately, can provide
useful information about the efficiency and distributional effects
(within and across generations) of alternative tax proposals under
either the current budget process or a process based on dynamic
scoring,
<bullet> Dynamic analysis is far less controversial because it can
highlight the inherent uncertainty involved in estimating the
macroeconomic effects of various policy initiatives, and
<bullet> Dynamic analysis is a necessary component in any budget
process that includes dynamic scoring because it would be used to
analyze and relay information about the macroeconomic effects of tax
proposals, which are not currently included in conventional revenue
estimates.
Implementing a budget process that encourages the adoption of
efficient, fair, and simple tax and spending policies is critical given
the fiscal gap facing the nation, which has been estimated to be as
high as $98 trillion in present value terms (Auerbach et al 2006). This
is equivalent to 10.8 percent of the present value of the sum of
projected Gross Domestic Product (GDP).
It is important to note that dynamic analysis is already used on a
limited scale. For example, CBO and JCT have produced dynamic analyses
of several significant tax proposals. More recently, the Department of
the Treasury's Office of Tax Analysis (OTA) has published dynamic
analyses of the reform proposals made by the President's Advisory Panel
on Federal Tax Reform and the proposal to permanently extend the
President's tax relief.
COMPARING ALTERNATIVE POLICY OPTIONS
A useful example is the OTA report (July 2006) that examines the
dynamic effects of the President's proposal to permanently extend a
variety of tax provisions enacted in 2001 and 2003. The report provides
information on the macroeconomic effects of the various tax provisions
as well as the aggregate macroeconomic effect of all the provisions.
This information allows for a comparison of the macroeconomic effects
of various policies and, if used appropriately, could prove useful in
structuring efficient tax policy. For example, the OTA report analyzes
the following three groups of provisions:
<bullet> Extension of lower capital gain and dividend tax rates;
<bullet> Extension of lower ordinary income bracket rates for the
25, 28, 33, and 35 percent brackets and an extension of the repeal of
the phase-out of personal exemptions and itemized deductions; and,
<bullet> Extension of the increase in the child credit from $500 to
$1,000 per child, the increased standard deduction and bracket width
for joint filers, and the 10 percent rate bracket.
The OTA report showed that lowering capital gains and dividend
taxes, coupled with a decrease in government consumption after 10
years, increased gross national product (GNP) by 0.4 percent in the
long run as lower effective tax rates on capital income increased
saving and investment. By comparison, if the revenue losses were offset
by an across-the-board tax increase after 10 years the report predicts
a 0.3 percent increase in real GDP in the long run. In fact,
permanently extending the dividend and capital gains tax cuts increased
real GNP in the long run for all of the options considered in the OTA
analysis. However, as noted by OTA, changes in a variety of simplifying
assumptions underlying the economic model used in this report could
strengthen or weaken these results. This includes assumptions about the
economic effects of dividend taxes and a variety of other economic
distortions that are not included in the model.
For the base case parameter values, the report showed that
permanently extending the cuts in the top four ordinary income tax
brackets and the repeal of the phase-out of personal exemptions and
itemized deductions increases real GDP by 0.7 percent in the long run
if the tax cuts are financed by reductions in government consumption.
However, if the tax cuts are financed by an across-the-board tax rate
increase after 10 years the policy has a negligible impact on real GDP.
By comparison, permanently extending the increase in the child credit,
the increase in the standard deduction and bracket width for joint
filers, and the 10 percent rate bracket reduces real GNP by 0.4 percent
if financed with government consumption after 10 years and by 1.2
percent if financed by an across-the-board tax rate increase after 10
years.
Purely from an efficiency perspective, a permanent reduction in
dividend and capital gains tax rates is preferred to lowering the four
highest ordinary income tax rates coupled with the repeal of the phase-
out of personal exemptions and itemized deductions in most cases
presented in the report. Similarly, a permanent reduction in dividend
and capital gains tax rates or the changes to the top four brackets are
preferred to an increase in the child credit, the marriage tax relief,
and the 10 percent bracket, as the latter are inframarginal changes for
most individuals. However, efficiency is not the only important factor
in determining fiscal policy--fairness and simplicity in administration
and compliance are also factors that should be considered.
POLICY GUIDELINES FOR IMPLEMENTING DYNAMIC ANALYSIS
House Rule XIII.3.(h)(2) of the Rules of the House of
Representatives, adopted January 4, 2005, in the 109th Congress,
includes the following requirement:
(2)(A) It shall not be in order to consider a bill or joint
resolution reported by the Committee on Ways and Means that proposes to
amend the Internal
Revenue Code of 1986 unless----
(i) the report includes a macroeconomic impact analysis;
(ii) the report includes a statement from the Joint Committee on
Internal Revenue Taxation explaining why a macroeconomic impact
analysis is not calculable; or
(iii) the chairman of the Committee on Ways and Means causes a
macroeconomic impact analysis to be printed in the Congressional Record
before consideration of the bill or joint resolution.
(B) In subdivision (A), the term `macroeconomic impact analysis'
means----
(i) an estimate prepared by the Joint Committee on Internal Revenue
Taxation of the changes in economic output, employment, capital stock,
and tax revenues expected to result from enactment of the proposal; and
(ii) a statement from the Joint Committee on Internal Revenue
Taxation identifying the critical assumptions and the source of data
underlying that estimate.
This rule is a good starting point for implementing dynamic
analysis but it could be improved. In particular, I offer the following
guidelines for implementing dynamic analysis into the policy process.
<bullet> While examining the aggregate macroeconomic effects of
various proposals is of interest, this approach ignores much of the
additional information that could be gleaned from dynamic analyses.
Thus, dynamic analysis should focus on comparing the macroeconomic
effects of competing provisions as well as presenting information on
the aggregate effects of all the provisions. Obviously, analyzing every
provision separately would be impossible and counterproductive, as this
would consume far too many staff resources. However, it is important to
ensure that the choice of provisions to be analyzed is not politically
driven, as this would undermine the integrity of the process. A balance
must be struck on this issue.
<bullet> Dynamic analysis should also be applied to spending
proposals, as the dynamic implications of expenditure policies may be
as important as those of tax policies.
<bullet> Debt service costs are generally included in dynamic
analysis but are not included in conventional cost or revenue
estimates. To be consistent, the debt servicing costs of conventionally
scored policies should also be considered in the policymaking decision.
Otherwise, the budget process may be biased towards proposals with
negligible or negative long run effects relative to proposals that are
associated with positive long run effects.
<bullet> Macroeconomic aggregates are not the only information that
should be provided to policymakers. Some measure of economic well being
should also be provided in addition to the macroeconomic aggregates.
This is important because positive macroeconomic effects can be
associated with negative welfare effects.
<bullet> Distributional analyses should also be conducted both
within income groups and across generations for certain policies. For
example, the President's Advisory Panel on Federal Tax Reform in the
United States decided against recommending a true consumption-based
tax, and instead, proposed a consumption-based system supplemented with
an ``add-on'' capital income tax at the individual level (the ``Growth
and Investment Tax'' or GIT). Given that the report showed that the
economic gains were larger under the consumption-based tax relative to
the GIT and that the transitional effects of the two proposals were
different, it would be interesting to compare how the plans differed
from a distributional perspective, both during the transition and in
the long run.
<bullet> The extent of the uncertainty contained in a dynamic
analysis should be well noted. For example, this would include
discussing the sensitivity of the results to various assumptions about
parameter values, the assumptions underlying the economic model,
whether the policy was financed by changes in government spending (and
the effects of such spending on welfare), taxes, or government debt,
and assumptions about the reactions of other entities such as the
Federal Reserve, state governments, and foreign countries.
<bullet> Dynamic analysis should be timely so that it can be used
effectively in the formulation of policy. The current House rule
(XIII.3.(h)(2)) requires an analysis of the macroeconomic effects
before the bill can be considered on the floor. This is somewhat late
in the political process, as many of the major details of a bill are
typically established at this point. It is important to note that there
are possible logistical constraints on this issue, given the current
state of macroeconomic modeling.
<bullet> Pubic disclosure is imperative. As much information as
possible should be released to the public. At a minimum, enough
information should be released so that outside entities could replicate
the work. This will ensure that the process is seen as fair and open
and will serve as a check on those who provide the estimates.
REFERENCES
Auerbach, Alan J., William G. Gale, and Peter R. Orszag, 2006. New
Estimates of the Budget Outlook: Plus Ca Change, Plus C'est la
Meme Chose, February 15, 2006.
Carroll, Robert, John Diamond, Craig Johnson, and James Mackie III,
2006. A Summary of the Dynamic Analysis of the Tax Reform
Options Prepared for the President's Advisory Panel on Federal
Tax Reform, U.S. Department of the Treasury, Office of Tax
Analysis, May 25, 2006, prepared for the American Enterprise
Institute Conference on Tax Reform and Dynamic Analysis May 25,
2006
Congressional Budget Office, 2003. An Analysis of the President's
Budgetary Proposals for Fiscal Year 2004 (March 2003).
Congressional Budget Office, 2003. How CBO Analyzed the Macroeconomic
Effects of the President's Budget (July 2003).
Joint Committee on Taxation, 2003. Overview of Work of the Staff of the
Joint Committee on Taxation to Model the Macroeconomic Effects
of Proposed Tax Legislation to Comply with House Rule
XIII.3.(h)(2) (JCX-105-03), December 22, 2003.
Joint Committee on Taxation, 2005. Macroeconomic Analysis of Various
Proposals to Provide $500 Billion in Tax Relief, (JCX-4-05),
March 1, 2005.
U.S. Department of the Treasury, Office of Tax Analysis, 2006. A
Dynamic Analysis of Permanent Extension of the President's Tax
Relief, July 25, 2006.
Mr. Crenshaw. Mr. Burman.
STATEMENT OF LEONARD E. BURMAN
Mr. Burman. Chairman Crenshaw, Ranking Member Neal, and
members of the committee, thank you very much for inviting me
to present my views on dynamic analysis and scoring.
With three economists on the panel, it is safe to say that
we would all like more attention paid to the economic effects
of public policies. The big question is whether dynamic scoring
or dynamic analysis is the best way to bring such analysis to
bear on public programs. My conclusion is that, given the
current state of economic knowledge, including macroeconomic
feedback effects, dynamic scoring and revenue estimates is not
feasible or desirable. However, dynamic analysis is a useful
complement to policymaking and some of the suggestions made by
Dr. Diamond and Dr. Holtz-Eakin would improve the process of
dynamic analysis significantly.
Federal tax and spending policies have an effect on the
economy and citizens well-being. Obviously, we should measure
those effects as accurately as we can, simply as a matter of
responsible budgeting. What's more, the effects of policies on
the economy clearly should be considered as a factor in
assessing their desirability.
All else equal, pro growth policies are better, although
there is often a tradeoff between economic efficiency and other
goals, such as fairness. Growth is only one factor to consider.
By long-standing practice, official revenue estimates are
dynamic in a microeconomic sense. They account for all the
measurable behavioral responses that can be anticipated
consistent with an assumption that macroeconomic aggregates,
including labor, supply, saving and gross domestic product, are
held constant.
What about the macroeconomic effects? Most economists would
agree that a major tax reform in which loopholes were
eliminated and tax rates lowered, holding overall revenues
constant, would increase economic growth, although there would
be a wide range of estimates of how much. But most tax
proposals considered by Congress would not fit in this no-
brainer category of growth enhancers. Most recent tax bills
contain a hodgepodge of good and bad provisions, at least in
terms of their effects on growth, including targeted tax breaks
that arguably weaken the economy and create new opportunities
for tax sheltering.
The biggest problem, though, is that recent tax bills have
produced significant revenue losses with no indication of how
those losses will be offset. Without knowing that, it is
impossible to assess the economic effects or even the measure
of whether the economy will be stronger or weaker in the long
run. Analysis by CBO, JCT, and Treasury have all concluded that
the way current tax cuts are paid for can fundamentally alter
the conclusions about their growth effects. It is impossible to
predict whether the tax cuts will ultimately be good or bad for
the economy unless you know how they will be paid for. Since it
is impossible for official scorers to predict how the deficits
will be closed, they can't produce a single point estimate or
dynamic score for the long term of deficit financed tax cuts.
As a related issue in the short run, the effectiveness of
tax cuts depends on whether and how the Federal Reserve
responds. Economists can provide some useful insights about the
potential range of economic effects of tax policies, especially
in the long run, but it is important to understand that
macroeconomic models are more valuable for demonstrating the
channels through which policy can affect the economy than for
providing numerical estimates.
Many fundamental parameters, including how people respond
to incentives to work and save more, are highly uncertain. We
do not understand well how people form expectations about the
future in the context of uncertainty. Because of limitations of
computational power, the models necessarily have to vastly
simplify reality. Tens of thousands of products, goods and
services are represented by, at most, a few representative
sectors. The range of differences of individuals in terms of
preferences, education, income, family structure and age is
similarly condensed. The mind-numbing complexity of the Tax
Code, which creates costs for businesses and individuals and
opportunities for tax sheltering, disappears in the models.
Nobody knows how important those simplifications are.
While careful researchers like Professor Diamond work
tirelessly to calibrate their models to reality as well as they
can, there is tremendous uncertainty about the statistical
properties of the model's long-term predictions.
I also want to reiterate Doug's recommendation that
specifying a finance mechanism is necessary for meaningful
dynamic analysis. It is also necessary for meaningful
distributional analysis, for measuring the benefit that
distribution of benefits and costs of tax legislation. And it
should be noted that the best financing mechanisms, from the
point of view of economic growth, would raise serious
distributional concerns.
For example, the recent tax cut package enacted by
Congress, according to the estimates by the Tax Policy Center,
would have provided an average tax cut of about $20 for the
people in the middle of the income distribution. But if you
assume that every household bears an equal share of the long-
term debt burden that goes with the tax cuts, a $20 tax cut
turns into a $466 tax increase over time.
Despite the limitations, dynamic analysis is potentially a
useful complement to policymaking. The models tell us that
certain kinds of policies rank better than others. Similarly,
microeconomic analysis of the efficiency effects of targeted
taxes and subsidies would be a useful complement to the policy
process.
That concludes my prepared remarks. I would be happy to
answer any questions.
Mr. Crenshaw. Thank you very much.
[The prepared statement of Leonard E. Burman follows:]
Prepared Statement of Leonard B. Burman, Senior Fellow, Urban
Institute\1\
Chairman Nussle, Ranking Member Spratt, and members of the
committee. Thank you for inviting me to present my views on dynamic
analysis and scoring.
With three economists on this panel, I think it is safe to say that
we would all like more attention paid to the economic effects of public
policies. The big question is whether dynamic scoring or dynamic
analysis is the best way to bring such analysis to bear on public
programs. (To define terms, dynamic scoring involves adding a point
estimate of macroeconomic feedback effects into official revenue
estimates. Dynamic analysis is a supplemental analysis of plausible
macroeconomic responses under a range of models and parameter
assumptions.)
A related question, which I will also touch on, is how the policy-
making process itself could be made more conducive to meaningful
economic analysis.
In short, my conclusions are these:
<bullet> Many behavioral responses are already included in official
revenue estimates of tax changes; that is, they are not static. The
estimates could be improved in several ways. However, given the current
state of economic knowledge, including macroeconomic feedback effects
(dynamic scoring) is not one of them.
<bullet> There are three key problems in analyzing the effects of
tax policy proposals: for deficit-financed tax and budget proposals,
the long-term economic effects depend critically on how the deficit is
financed (that is, on who ultimately pays for the tax cuts or new
spending), and that is inherently unknowable by any estimator; there is
tremendous uncertainty about key parameters that reflect how people
make decisions about working and saving that can have large effects on
estimates; and the limits of data, computing power, and economists'
ingenuity mean that our models have little relationship to the way real
people make real decisions.
<bullet> That said, most economists would agree that certain kinds
of tax and spending policies are better for economic growth than
others, so we could produce a rough ranking regardless of the financing
mechanism or long-term economic model. For that reason, economic
analysis of specific provisions as well as entire packages is useful.
While dynamic analysis typically has been equated with macroeconomic
modeling, for many specific provisions, an analysis of the
microeconomic effects is all that is feasible at present. Such analysis
would be a useful complement to policymaking.
INTRODUCTION
Federal tax and spending policies have an effect on the economy and
citizens' well-being. Obviously, we should measure those effects as
accurately as we can simply as a matter of responsible budgeting.
What's more, the effects of policies on the economy clearly should be
considered as a factor in assessing their desirability. All else equal,
pro-growth policies are better, although there is often a trade-off
between economic efficiency and other goals, such as fairness; growth
is only one factor to consider.
MICRO-DYNAMIC REVENUE ESTIMATES
By longstanding practice, official revenue estimates are dynamic in
a microeconomic sense. They account for all the measurable behavioral
responses that can be anticipated consistent with an assumption that
macroeconomic aggregates--including labor supply, saving, and gross
domestic product--are held constant. Thus, the official estimates of
the income tax rate cuts enacted in 2001 assumed that at lower tax
rates, taxpayers would report more taxable income because, for example,
they would earn a smaller fraction of compensation in the form of
untaxed fringe benefits and perhaps be less prone to cheating. However,
the estimates accounted for neither a boost in hours worked or saving,
which might have increased growth, nor a drop in investment or demand
for homes and other consumer durables as a result of swelling public
debt and higher interest rates, which would have retarded growth.
There are ways to improve revenue estimates, but dynamic scoring is
not, at present, one of them. A problem that could be rectified is that
estimators must provide a single point estimate that assumes that a
host of unknown factors are known with certainty. This can cause the
cost of particular types of tax proposals to be consistently
underestimated. For example, in 2004, Congress effectively created a
price support program for certain low-yielding oil wells. If prices
fell below a certain trigger price, a tax credit would offset the
difference between the actual price and the trigger price. Since the
trigger was set below then-prevailing oil prices, the provision was
scored as having no revenue effect, even though under some scenarios it
could have been very costly to the Treasury. A better rule would be to
estimate the expected revenue loss--that is, the average across all the
plausible price scenarios--to get an idea of what the price guarantee
would cost the government (and be worth to recipients).\2\
More fundamentally, the legislative process itself may introduce
biases into revenue estimates in a subtle way. The reason is that
revenue estimates are subject to error. Under the best of
circumstances, the errors will average out to zero. However, if overall
budget targets are binding, then tax cuts and spending programs that
appear to cost less will be favored over those that appear to cost
more. (Indeed, the principal argument for dynamic scoring is that
advocates believe that tax cuts would be more feasible if official
estimators predicted that they would cost less in terms of lost
revenues.) That means that tax cuts that are underestimated (and tax
increases that are overestimated) will be more likely to be enacted
than those that err in the opposite direction. As a result, despite the
best efforts of estimators, the errors in policies that are actually
adopted will tend to go in the same direction--they will not average
out to zero. Revenue estimates will be consistently over-optimistic and
deficits larger than predicted (or surpluses smaller). This might argue
for a deliberate offsetting conservative bias in revenue estimating to
make estimates more accurate on average.
Berkeley economist, Alan Auerbach looked at the accuracy of
baseline receipts forecasts over many years and did not find evidence
of consistent bias one way or the other.\3\ However, Auerbach found
that receipts projections tend to be inefficient in the sense that
aggregate errors tend to repeat from year to year. Building on
Auerbach's work to adjust baseline outlay and receipts forecasts could
make budgets more accurate although, as he notes, that is easier said
than done.
PITFALLS OF INCORPORATING MACROECONOMIC EFFECTS IN ESTIMATES
What about macroeconomic effects? Most economists would agree that
a major tax reform in which loopholes were eliminated and tax rates
lowered, holding overall revenues constant, would increase economic
growth, although there would be a wide range of estimates of how much.
Unfortunately, the vast majority of tax proposals considered by
Congress would not fit in this no-brainer category of growth enhancers.
While everyone likes lower tax rates, base broadening is a lot more
popular with economists than it is with the people who pay higher taxes
as a result. Tax cuts enacted since 2001, for example, have lowered
marginal tax rates, but they also narrowed the tax base by creating a
slew of new targeted tax breaks--including that one for unproductive
oil wells I mentioned earlier--that are likely to hurt the economy
rather than help it. This makes assessing the net effect problematic.
The biggest problem, though, is that recent tax bills have produced
significant revenue losses with no indication of how those losses will
be offset. Without knowing that, it is impossible to assess the
economic effects, or even to measure whether the economy will be
stronger or weaker in the long run.
Depending on how the deficits are closed, there could be
dramatically different economic results. The best-case scenario for
economic growth is for deficits to be financed by cuts in transfer
programs or increases in lump-sum taxes (fixed per capita taxes not
related to ability to pay). That deficits might force spending
constraint appears to be the logic behind the ``starve the beast''
rationale for deficit-financed tax cuts, but there is no evidence that
this tack actually works. It is not clear why spending cuts would be
easier in the future than they are now. Will it be easier to cut Social
Security and Medicare 20 years from now when all the baby boomers are
retired (and AARP's membership has exploded)?
The worst-case scenario for economic growth is this: years from
now, our profligate budgetary policies lead to dramatically higher
interest rates and a massive recession, if not a depression. Taxpayers
blame this on the tax cuts for the rich and decide to deal with budget
problems by raising tax rates on high-income folks. (And they leave in
place all the middle-class tax cuts like the child credit, higher
standard deduction, and 10-percent bracket.) I think it is safe to say
that in JCT's, CBO's, and Treasury's models, such a tax increase would
prove most damaging to growth. The net effect would be a much smaller
economy than would exist had the tax cuts not been enacted.
To be clear, this long-term risk also means that deficit-financed
spending would also be more costly than would appear in either a
balanced-budget scenario or one assuming less damaging deficit offsets
in the future.
Since it is impossible for official scorers to predict how the
deficits will be closed, you cannot expect them to produce a dynamic
score for the long-term effect of deficit-financed tax cuts. For
related reasons, it is a challenge to predict the short-term effects as
well. In the standard Keynesian macroeconomic model, short-term fiscal
stimulus (a spending increase or tax cut) boosts the economy during
downturns by spurring households to spend and businesses to invest,
creating more demand and thus more jobs. When the economy is at full
employment, deficit-financed tax cuts can hurt by creating inflationary
pressure. If the economy is running at capacity, companies will respond
to higher demand by bidding up wages to try to keep or retain workers,
which translates into higher product prices and inflation.
The wild card is the Federal Reserve, which tries to stimulate the
economy when it is underperforming and slow it down when inflationary
pressures arise. Fed policymakers are likely to respond to tax cuts by
tightening up monetary policy to prevent inflation. Since monetary
policy affects the economy more slowly than fiscal policy, short-term
deficits that are larger than the Fed had expected can still have an
immediate effect, but the effect beyond that is complicated by the
Fed's response. While this is probably more predictable than how future
Congresses will deal with the national debt, it significantly
complicates forecasting the effects of fiscal policy beyond a year or
so.
VALUE AND LIMITATIONS OF LONG-TERM MACROECONOMIC MODELS
A model of the economy can be a very useful tool in assessing tax
reform options. A well-designed model incorporates individuals' and
firms' decision processes and their interaction with each other and
with government policy. Although the point predictions of such models
are of questionable value, since they depend on parameters that are
highly uncertain, the models do demonstrate the channels through which
tax policy can affect the economy. They also allow for consistent
comparisons of different policy options.
There are four basic kinds of models used for macroeconomic
analysis of tax policy (with almost infinite variations): neoclassical
growth models; disequilibrium (or Keynesian) models; infinite horizon
models; and overlapping generations (OLG) models.\4\ The first two
types of models represent a very stylized version of the economy.
Individuals and firms do not make optimizing decisions. Instead, the
results of those optimization decisions are reflected in numerical
measures of the response of saving, labor supply, and factor
substitution (firm's ability to substitute capital and labor for each
other in the production process), which are known as elasticities.
Taxes can affect the economy by altering the return to saving and
working for individuals or the costs of labor and capital for firms.
Such models are often enhanced by disaggregating different economic
sectors (such as manufacturing, agriculture, services, etc.) on the
assumption that they have different production technologies (i.e., use
capital and labor differently) and often include different classes of
workers who have different skill levels.
The neoclassical growth model assumes full employment: markets for
all goods and services always clear instantaneously so unemployment,
which is a disequilibrium between the supply and demand for labor, is
not possible. Disequilibrium or Keynesian models assume that such
disconnects are the norm, but that they can be affected by government
policy and the business cycle. Thus, during a recession, tax cuts can
reduce unemployment and increase GDP because lower taxes spur
individuals to spend more or companies to invest more, which increases
the demand for goods and services, translating into more jobs.
Modern disequilibrium models are typically combined with standard
growth models. In such models, tax changes can affect labor supply and
saving, which affects output and the demand for capital in the next
period. The changes alter the return to capital and labor, which adjust
again affecting output and the demand for productive inputs. The
process continues until the demand and supply for capital return to
equilibrium, from which point on the economy grows at a constant
steady-state rate.
Such models have been used for decades and are well understood.
They are attractive because their results are fairly easy to explain
and intuitive, but they have some limitations. First, Keynesian models,
being inherently short-term in focus, do not tell policymakers about
the long-term effects of tax policy, when, presumably, the level of
equilibrium is of most interest. Indeed, they may not provide the
answer tax cut advocates want in the short term. Such models typically
predict that spending increases or cuts will have a larger effect than
tax changes because government spending immediately generates
additional demand for goods and services, whereas tax cuts affect
demand only to the extent that the recipients choose to spend them
rather than save. In such models, tax cuts are good, but spending is
better and deficits are a plus in the short-term.
A more fundamental problem with both the disequilibrium and the
growth models are that they are too aggregated. They assume, for
example, that labor supply and saving decisions of individuals (or
groups of individuals) depend only on the average tax rate on labor and
capital income. Thus, replacing a progressive income tax with a flat
rate tax that raises the same amount of tax revenue would be expected
to have no effect on work or saving decisions since the average tax
rate remains the same. But reducing high tax rates is likely to produce
a larger positive effect than the negative effect of increasing tax
rates at the bottom or broadening the tax base. The individual
decisions do not average out to zero. Similarly, policies that affect
individuals' and firms' expectations about the future can have big
effects on their behavior now, but the neoclassical and disequilibrium
models are not forward-looking.
Infinite horizon (or Ramsey) models and OLG models are more modern
representations of the economy based on the decisions of individuals
and firms. Individuals maximize utility subject to an intertemporal
budget constraint (that is, typically, they cannot die in debt). Firms
maximize profits. The government must balance its budget over the long
term (although not necessarily over any finite interval). In some such
models, people have perfect foresight: they can predict the future
accurately. In other more realistic models, the future is uncertain so
results depend on how people are assumed to form expectations. Rational
expectations models assume that people have a very good macro model
inside their heads so that their forecasts are correct on average.\5\
Other models assume myopia--people assume that the present will
continue--or adaptive expectations.
In infinite horizon models, people (and firms) live forever.
Obviously, this is an unrealistic assumption, but advocates of such
models argue that they are a good and relatively simple representation
of a world where people care about their children as much as they care
about themselves. Therefore, the preferences of children enter their
parents' utility functions and are represented in a motive to leave
bequests. Since children will also care about their children, and so
on, the very long time horizon may be warranted.
The OLG models represent the very long term by assuming that
individuals live for a fixed number of years, but are replaced by
children and grandchildren with similar preferences who are young when
the parents age. By solving for the decision process of each generation
and connecting them (primarily through interest rates), there is,
again, a very long horizon in such models.
An advantage of this class of models is that it is possible to
build in great detail on the tax structures facing individuals and
firms. A disadvantage is that the models depend on parameters about
which little is known. In particular, the models depend on the
parameters of individuals' utility functions: their trade-off between
consumption and leisure (and thus labor) in the current period, and
their willingness to trade future consumption and leisure for current
consumption and leisure. For example, if people expect taxes to
increase in 20 years, will they work harder and spend more now, and if
so, by how much? These intra- and intertemporal elasticities (and, to a
lesser extent, factor substitution elasticities of firms) are critical
to the predictions of such models, but very little is known about the
proper values. Critics have also pointed out that there is a
considerable amount of evidence that individual decisions deviate in
important ways from the predictions of the life cycle model, which
underpins both of these frameworks.
These models are also very sensitive to their exact structure. The
CBO found larger growth effects in the infinite horizon model than in
the OLG model; the smallest long-term effects arose in the neoclassical
growth model. Different forms of uncertainty and assumptions about
individuals' attitudes towards uncertainty can also produce markedly
different predictions about the effects of a given policy.
A key implication is that a single model will not be adequate for
evaluating the long-term effects of public policies since the results
may be very sensitive to the choice of model. When employing any model,
parameter assumptions should be subjected to extensive sensitivity
analysis. That is, different values for key parameters, such as labor
supply and saving elasticities, in the case of the disequilibrium and
growth models, and intra- and inter-temporal elasticities of
substitution, in the case of the infinite horizon and OLG models,
should be tried to see how sensitive the results are to the parameter
assumptions.
Put differently, there is no basis for producing a single point
estimate for the macroeconomic effect of tax or spending policies, even
when they are not deficit-financed. While the kind of dynamic analysis
that CBO and JCT have done using a range of models can be an
informative input to public policy, it is of virtually no value in
improving estimates of the short- or long-term effects on revenues.
Indeed, since none of these models has been validated in actual
practice, choosing a particular model, a set of parameters, and
assumptions about the way deficits will be offset and the Federal
Reserve will react would almost surely add new biases and significantly
increase the variance of revenue estimates. This problem also raises
the risk that policymakers will gravitate towards policies whose
macroeconomic feedback effects are most overstated in a particular
model chosen by estimators, even though these policies may not
necessarily be the best ones for the economy in the long run. It
certainly raises the risks that forecast accuracy would be
significantly worse with this approach.
THE POTENTIAL USEFULNESS OF DYNAMIC ANALYSIS
Despite its limitations, dynamic analysis is potentially a useful
complement to policy making, although existing models are quite limited
in what they can simulate. All else equal, it would be nice to
discriminate in favor of pro-growth policies, especially if the growth
benefits are widely shared rather than concentrated at the top.
Note, however, that this is not necessarily an argument in favor of
tax cuts. First, as noted, when financing is considered, almost any tax
cut could turn out to be counterproductive over the long run. Second,
some tax cuts would tend to reduce economic growth no matter how they
are financed and some spending increases would tend to enhance growth.
For example, a horse-and-buggy tax credit would certainly create
jobs in the horse and buggy industry, potentially reversing a century-
long downturn, but almost nobody would argue that this would be good
for the economy overall. The resources that were diverted into horses
and buggies could surely be better used in any of thousands of goods
and services that consumers value more.
You might think that Congress would never enact such a thing, but
the manufacturers' tax deduction and many of the other targeted tax
breaks, enacted as part of the American Jobs Creation Act of 2004, are
not much different. They distort market prices and interfere with the
efficient allocation of scarce economic resources. While there may be a
role for targeted taxes or subsidies in markets when they are not
working--for example, when there is pollution--many if not most tax
breaks cannot be justified on those grounds.
On the other side, some kinds of government spending may produce
economic benefits over and above their direct value to beneficiaries.
Some examples include investments in infrastructure, education,
information, and research and experimentation. Not all such projects
produce benefits in excess of their costs (as the recent debate about
the bridge to nowhere in Alaska illustrates), but well chosen public
investments can produce substantial payoffs.
Unfortunately, the kinds of models designed to do dynamic analysis
are not well suited to discriminating among good and bad kinds of
targeted tax incentives or spending programs. Typically, such models
represent different sectors at a highly aggregated level and have only
a rudimentary representation of the tax system and no detail at all
about spending. Indeed, in some macroeconomic models, government
spending is tantamount to throwing the money (and the real resources it
represents) into the ocean.
However, government analysts can do a microeconomic analysis of the
efficiency effects of different programs and, indeed, the CBO, GAO, and
CRS do when Congress asks. . Often, the analysis can be informed by
empirical estimates--as in the case of investments in infrastructure,
education, and research--although the research findings can vary
wildly.
At a minimum, as part of the summary analysis of each piece of
proposed legislation, it would be nice to include a qualitative
analysis of the likely efficiency effects of each provision.
OTHER ADVANTAGES OF SPECIFYING FINANCING FOR TAX CUTS
As noted, the way tax cuts (or spending increases) are financed can
fundamentally alter the assessment of their long-term economic effects.
It also affects how we assess the distribution of tax benefits. The
standard distribution table ignores the question of how deficits will
be financed. As a result, tax cuts can look like good news for almost
everyone. Advocates can argue that everyone is a winner and may appear
to be right. Anyone arguing against the tax cuts is just a selfish
demagogue practicing the ``politics of envy.''
If we were explicit about financing, however, the picture would
change. A deficit-neutral tax change has to make some people worse off
and those people often object. The people who will pay for the
government's current generosity appear to be our children, and maybe
that works politically because children and those not yet born don't
vote. However, if one accepts the key assumption of the infinite
horizon model that parents care as much about their children and
grandchildren as they do about themselves, then being explicit about
who will bear the burden of current tax cuts would create political
fallout.
How the tax cuts are financed then becomes very important. Under
the scenario where a future Congress decides to close the deficit by
soaking the rich, the President's tax cuts become a lot more
progressive than they appeared before financing was considered. If,
instead, we follow the growth-maximizing path and slash spending, then
many, if not most, taxpayers will find that they lose much more in
future benefits than they gain in short-term tax cuts.
Thus, the best case for economic growth (all households take an
equal share of resulting future debt service) produces the bleakest
case for progressivity. For example, under any of the major tax cuts
passed since 2001, the vast majority of households would be worse off
under this financing option unless the economic benefits turned out to
be implausibly large.\6\ And the best case for progressivity (high-
income taxpayers face income tax rate hikes to offset the debt) is the
worst case for long-term economic growth.
If Congress has in mind financing options that involve less
draconian trade-offs, it should be explicit about them.
CONCLUSION
Dynamic scoring is not feasible because of lack of knowledge about
how deficits will be offset, uncertainty about key parameters in
economic models, and inherent limitations in those models themselves.
Dynamic analysis, however, is useful, but it should be applied to
spending as well as taxes. What's more, the economic analysis of tax
and spending provisions should be done on a provision-by-provision
basis, not just overall packages.
Finally, both dynamic analysis and the assessment of the
distribution of winners and losers from tax changes could be made much
more accurate if Congress specified a financing mechanism for each
major piece of tax legislation.
ENDNOTES
\1\ Views expressed are mine alone and do not necessarily reflect
the views of any organization with which I am affiliated.
\2\ The CBO now applies ``probabilistic scoring'' to measure the
cost of similar spending programs.
\3\ Alan J. Auerbach, ``On the Performance and Use of Government
Revenue Forecasts,'' National Tax Journal. Vol. 52 no. 4 (December
1999) pp. 765-782
\4\ For a good survey, see Jane G. Gravelle. 2003. ``Issues in
Dynamic Revenue Estimating,'' CRS Report for Congress RL31949, U.S.
Congressional Research Service; or the Appendix of U.S. Congressional
Budget Office. 2003. ``How CBO Analyzed the Macroeconomic Effects of
the President's Budget.'' CBO Paper. Available at: http://www.cbo.gov/
ftpdocs/44xx/doc4454/07-28-PresidentsBudget.pdf.
\5\ Ironically, a consequence of this assumption is that it is
impossible for economists to develop an accurate aggregate model of the
economy because individuals' behavior changes the parameters of the
economists' models, invalidating them.
\6\ Jason Furman, ``A Short Guide to Dynamic Scoring,'' Center on
Budget and Policy Priorities, August 24, 2006. Available at http://
www.cbpp.org/7-12-06bud2.pdf.
Mr. Crenshaw. And now we will go to questions. And I want
to ask unanimous consent that all members be allowed 7 days to
submit statements for the record. Without objection, so
ordered.
Let me start by, first of all, saying I appreciate some of
the clarification. There is a lot of misunderstanding from time
to time among members in terms of static versus dynamic. The
fact that Dr. Holtz-Eakin talked about, the fact that static
scoring is not exactly that, in the sense that when projections
are made, consideration is given to changes in behavior. But in
the final analysis, the dynamic analysis is much broader and
only occurs in certain instances big enough to have a big
enough impact.
And as Mr. Neal pointed out earlier, if you do a dynamic
analysis and you find that the GNP is only impacted .1 percent,
while it might seem significant, that is $13 billion. And as
Dr. Holtz-Eakin pointed out, if our economy grew .4 percent
faster than Great Britain over a period of years, it all adds
up at the end of the day. So it is, I think, a valuable
exercise, and it is good to hear some of the difference between
what we often think is just purely static and dynamic.
Let me start by just asking the question that this is one
of the, I guess, concepts, this dynamic scoring concept that is
part of this legislation that I filed. And I should say that
Mr. Spratt and Chairman Nussle had worked on similar
legislation to kind of modernize what goes on. The last time we
actually did anything in terms of these budget concepts was
1967. And that is still kind of bible, and the world has
certainly changed in the last 40 years.
So as we deal with entitles, as we deal with trust funds,
as we deal with public/private partnerships, maybe the question
to Dr. Holtz-Eakin is, is this the kind of legislation that you
see that we need today to kind of modernize those concepts?
Mr. Holtz-Eakin. I think it is high time for a thorough
rethinking of budget concepts, and I think the notion of having
a commission go back and replicate the effort in 1967 was
entirely desirable. There are many instances where the
threshold question, what is on and what is not on the Federal
budget, are now murky and that needs to be clarified. You know,
when is it that the taxpayers are at risk for providing
resources to meet obligations undertaken by the Federal
Government. And so a commission that simply did a rethinking of
what the boundaries were, reclassified transactions for whether
they are appropriately on the spending or the tax side, the
profusion of those things which are labeled offsets to
spending, which are really receipts by any other name, or tax
credits which are called tax cuts but which are spending by any
other name makes the budget less clear. I think having a
commission undertake that kind of rethinking would be entirely
desirable at this point in time.
Mr. Crenshaw. Thank you. And maybe, Mr. Diamond, you
mentioned that the kind of macroeconomic impact that I guess
Treasury put together, there is a chart in our kits, can
somebody put that chart up and maybe--I can't see it very good.
But maybe can you highlight some of the points you made about,
when you look at that base simulation, you know, if you extend
the lower dividends and capital gains tax rates and then you
see that if you have got to make a choice between lower
spending or increasing taxes, highlight a couple of those
points that you made earlier, as I look, I can see, I think
that is what maybe Mr. Neal was referring to. If you look at
that real GNP, you get .1 percent growth. If you were to lower
the ordinary tax rates, that second column, and then I think
the best I can see 1.1 percent, GDP might grow 1.1 percent,
which would be very sizable. Highlight a couple of those so
that we can see kind of more clearly what you talked about when
you discussed that Treasury, maybe what was your input into
that.
Mr. Diamond. Well, I started off with one of the points
that has been made in the testimony of many people over the
years, which is the positive-negative relationship between
dynamic scoring and the fiscal offset. So if you assume one
fiscal offset, you get a positive result, and if you assume
another fiscal offset, you get a negative result and you can
see that in column 3. The effects of the total package are in
column 3, the second column of column 3. If it is financed by a
decrease in government consumption, so this would be the full
tax relief proposed by the President, you would see that it
would increase real GNP by 0.7 percent, whereas if you financed
it by an increase in future taxes, real GNP would actually
decrease by 0.9 percent.
This is a standard argument that it is kind of a zero-one
assumption. And I guess my point was, one, to point out that we
can actually compare the alternative policies, the dividend
cuts, versus the lower ordinary rate brackets, versus these
other three things, the increase in the child credit, the
increased standard deduction and bracket width for joint
filers, and the increase, or the 10 percent bracket, and that
when you compare those, that you see that the growth effects of
the dividend and gains cut is larger than column three for the
credits and deductions and so forth. And also, that you can see
that there is an increase in growth from lowering the ordinary
tax rate brackets. So if you take the 0.4 percent number and
then you look at column two and you get real GNP goes up by 1.1
percent, the different between those numbers is a rough
estimate of the effect of lowering the tax rates in the top
four income brackets. So with a government consumption offset,
after 10 years, you get that basically increased growth by 0.7
percent, and with a tax offset, it does not affect growth
because your number is the same as with the dividend tax cuts
in column one.
And the final point I was kind of hoping to make is that it
is not always a positive negative outcome. We see for the
dividend taxes that in all of the cases provided in the
Treasury report, that the tax cuts led to a larger economic
growth. So maybe we should look for those types of proposals
and pass those types of tax cuts instead of the types of tax
cuts that lead to negative long run growth.
Mr. Crenshaw. And that is kind of an example of a dynamic
analysis that Burman said it is not scoring, but it is kind of
information that would be helpful in making these kind of
policy decisions.
Mr. Diamond. Exactly. If you have 6 to 10 proposals, you
could look at each one, at least in this example, in terms of
how they would affect long run growth and then obviously, like
we have both noted is that you would also want to, you know,
you have other things, you have other factors that you
consider, but this at least gives you some hard evidence on one
factor that goes into your policymaking decision.
Mr. Crenshaw. Thank you very much. Mr. Neal.
Mr. Neal. Thank you very much Mr. Chairman. And thank you
for your expert testimony this morning. Just a general question
to the three of you. Does Congress currently constitutionally
have the tools to balance the budget? Mr. Eakin.
Mr. Holtz-Eakin. Absolutely.
Mr. Neal. Mr. Diamond.
Mr. Diamond. Yes.
Mr. Neal. And Mr. Burman.
Mr. Burman. Yes.
Mr. Neal. Thank you for clearing up that notion. The reason
I raise that question is, one of the things that I witnessed
during the time that I have been here, the 18 years, is that
the more we employ gimmickry, somehow the scenario will change.
So in the 1990s, if we simply had term limits, all would be
well. Fascinatingly enough, many of the people that voted for
them and were most vociferous in their support of them, geez,
they all stayed because the country needed them.
Then there was the argument from the caucus of the line-
item veto that really should be called the stop me before I
spend again caucus. And then, of course, raging with popularity
in the 1990's and, by the way, being discussed again is this
notion of a balanced budget amendment to the Constitution.
Finally, I take you back to January of 2001, what the scenario
looked like financially for the Nation. Long term projected
surpluses, without any gimmickry, and I guess the question that
I would like to pose to the three of you, is there any
evidence, Mr. Eakin, first, that these tax cuts pay for
themselves?
Mr. Holtz-Eakin. Tax cuts don't pay for themselves,
although I think it is important to--I believe that. I don't
want to be evasive. But the question is what does ``pay for
itself'' mean? I think this term gets tossed around a lot
without a precise definition of what that means. So I would
like to hear someone define that before I answer it.
Mr. Neal. Well, let me throw this out to you. If you are
late on your mortgage payment for 7 months, and if the bank is
in foreclosure proceedings, and if you call the bank and say
please, I will change my behavior if you will forget about
this; what is the bank's position?
Mr. Holtz-Eakin. Rather unsympathetic.
Mr. Neal. Thank you. Would the other two panelists like to
respond to the first question I raised about the notion of
whether or not these tax cuts really do pay for themselves? Mr.
Diamond.
Mr. Diamond. They don't. That is clear.
Mr. Neal. Thank you. Mr. Burman.
Mr. Burman. Obviously they don't. Greg Manke, who was
President Bush's first CEA chair, said in a textbook that
people who thought that tax cuts paid for themselves were like
snake oil salesman trying to sell a miracle cure.
Mr. Neal. The Congressional Research Service and the
Treasury have both drawn the same conclusion that our three
panelists have drawn. And their argument is that little will be
of consequence in terms of those tax cuts paying for
themselves. But there is an element in the Congress that
insists on ignoring the evidence at hand, and that is why we go
through many of these procedures that we do, and I think that
your testimony today has been very helpful.
Thank you, Mr. Chairman.
Mr. Crenshaw. Thank you. Mr. Barrett.
Mr. Barrett. Thank you, Mr. Chairman. Gentlemen, thank you
for coming this morning. I have got a couple of questions for
you. If you compared the margin, and Dr. Holtz-Eakin, if you
would answer this. If you compared the margin of error, let's
say, static analysis versus dynamic analysis, I mean, can you
give us some kind of figures that dynamic analysis is much more
effective? Or, I mean, compared to the two?
Mr. Holtz-Eakin. I would hesitate, I can't give you numbers
that would illuminate that. I think that the right answer to
that question is two dimensions. I mean, the first is that, by
definition, the current, quote, static procedures leave out
potential responses that the dynamic analysis would put in. And
that is just the nature of the beast.
And so to the extent that those responses, economic growth
responses are important to the Congress, then it is ``better to
get them in.''
The second piece is that I don't divide scoring issues
reflexively into static and dynamic. I think I divide them into
those things we know a lot about it. We have seen programs like
it before. We have collected a lot of evidence. The research
community has looked at that evidence and come to some
conclusions and those scoring issues like the very first
terrorism risk insurance bill, where we are in a new world and
there is no evidence. Well, I don't think that is a static
dynamic problem. That is we don't know a lot about this
particular program.
We don't have a lot of evidence, and the techniques brought
to bear on it are far less the source of uncertainty than the
fact that we just don't have much in the way of evidence.
Mr. Barrett. I know that Dr. Holtz-Eakin and maybe Dr.
Diamond, you mentioned that the process is a little more
complicated than the static method. And I firmly believe we
need to go to a dynamic type of analysis. But should it be when
we are talking about overall budget reform and trying to be
more accurate, when we are talking about this, does it make
sense, when we are talking about dynamic analysis, also talk
about further budget reforms, like, No. 1, a biannual budget so
you guys are only having to go through this process once every
2 years and possibly because of the complexity and the added
things in the process, doesn't it make more sense? And I am
asking this to all three of you guys, for a major overhaul of
the Tax Code, another step in the right direction to simplify
things, whether it is a flat tax, consumption tax, just a major
going back and taking a look at not only dynamic analysis, but
the budget process and possibly the Tax Code? And I pose that
question to all three of you guys.
Mr. Diamond. I will take part of it, which is the added
complexity in dynamic analysis, or the dynamic scoring process.
I mean, you would have added a number of questions because you
are now asking not only about the micro behavior, but you are
also asking about the macro behavior so there is definitely
some additional complexity. But that complexity, I am not
always certain that that makes it less reliable. To some
extent, the standard or conventional revenue estimating process
is extremely uncertain. And when I was at JCT, I was making
decisions daily that I had no evidence for. But because I
needed to have an estimate, a member had asked for an estimate,
and I was responsible for presenting it, so that is what I did.
And I made an educated guess. And so I am not certain that we
should throw dynamic scoring out because of its uncertainty or
its complexity. Revenue estimating and I think cost estimating
are uncertain by nature, and I am not sure that assuming that
all the effects are zero is always the best assumption. I think
a lot of times it is a very good assumption.
The other problem is that you do have to, when we do
dynamic analysis, include this government offset effect, or
this debt effect. But in policies that don't receive a dynamic
analysis we don't consider the effect or the debt effect or the
debt servicing cost of that proposal. So if you have one policy
that is pro growth and its growth is offset by the cost of
servicing the debt, you have one policy that has no growth
effect, but it is not analyzed dynamically, so you just kind of
see it as it is conventionally scored, and I think there could
be a real misperception there of when it comes to comparing
which of those policies would be good for the country. And I
will leave the other questions for the other guys.
Mr. Burman. I am pretty skeptical about the value of
dynamic scoring in most contexts. The one exception might be
that if we actually did have a major tax reform that was
revenue neutral and we were broadening the base and lowering
the rates like we did in 1986. So I think the idea of thinking
about this in the context of a major overhaul of the tax
system, which I think is really necessary given the huge
demands that are going to be put on it in the decades to come,
is a good idea.
Mr. Holtz-Eakin. Your question really had two different
pieces to it, one of which is process issues. And dynamic
scoring would be one part of changing the process of
deliberation. And I think it is important to step back and
recognize that, you know, the Congress adopts policies for
their benefits and they have an enormous amount of information
about their benefits provided by their constituents, first and
foremost, by analyses, from interested groups and think tanks
and things like that.
The budget is there to reflect and report the costs. And
what the current budget costs don't reflect are the efficiency
costs and the economy. When you get a dollar of Federal
revenue, you don't ask the question how much did we muck up the
economy in the process of collecting that dollar? What dynamic
scoring would do would be to include that efficiency cost, at
least in part and imperfectly into recognizing the cost of
Federal programs. Since budget are supposed to reflect costs,
that strikes me as entirely desirable. To extend the mandates
of dynamic scoring to somehow also reveal all the
distributional fairness benefits or all the other things I
think is unfair. We are not asking the budget to tell us what
the best policies are. We are asking it to tell us what they
cost.
And so I think as a part of the process reforms to get in
order our fiscal House, going forward, it strikes me as
sensible. As I tried to be clear, I don't think it going to
change dramatically most things. But for some big things it
will be important.
Well, what are the big things where it will show up? All
the things we are going to face. Anything that has a profound
impact on how we raise the revenue, like a major tax reform. We
are going to face big issues in our retirement programs.
Medicare, Social Security. Any changes in those have profound
impacts on how much people work over their lives, how they save
for their retirements. They will have profound impacts on the
economy. So all the big issues that are coming up will require
this sort of understanding, and it seems to me that to build
into the process the capacity to get those feedbacks is
entirely sensible. And I am really cognizant of all the
problems. I tried to list them all and be honest about it. But
I don't think it is sensible to say, gee, we have all these
problems and we can't do it, because that is the luxury of hand
wringing in public.
You know, once you are on the other side of CBO and someone
wants a number, as Mr. Diamond was real clear, you give them
the number. You don't have the luxury of wringing your hands.
You do it. So think hard about what you want to do, make
provisions to get it done in a sensible fashion. And then I
think all the work after that is a really a matter of
understanding it on the part of members, understanding what you
are getting in a dynamic analysis. It is clear there is not a
complete understanding of what is going on in the current
scoring process. So there is a lot of education on the other
side as well as just the issue of getting it done.
Mr. Barrett. Thank you, Mr. Chairman.
Mr. Crenshaw. Mr. Baird.
Mr. Baird. I thank our distinguished witnesses. It is good
to see you again, Dr. Holtz-Eakin. We have missed you around
here.
First a question about logic, really. We often hear people
say there was a tax cut if the revenues increased. Therefore,
tax cuts caused the increase in revenues. I would like each if
you if you may briefly say is that justified.
Mr. Holtz-Eakin. You can't draw the conclusion from that
and try to estimate that component.
Mr. Baird. Mr. Diamond, would you concur with that?
Mr. Burman.
Mr. Burman. I agree. There are some very silly arguments.
Like we end up saying well, we had tax increases in the 1990's
and the economy grew really fast, and therefore, the tax
increases cause economic growth and we had tax cuts in this
decade and the economy grew, without allowing for all the other
things that are happening at the same time.
Mr. Barrett. I appreciate that. I hope folks will remember
this election season, especially in the context if I where
given, say, $600 billion of deficit spending plus 2 to 3
percent interest rates, I think I could make the economy grow,
regardless of what happened with taxes virtually, and nobody
seems to talk about that. Back home it seems to me, folks got
more money in their pocket from refinancing their house than
they ever got from a so-called middle class tax cut. Any
thoughts on that on those other factors? Say, low interest
rates or deficit spending as stimuli to the economy?
Mr. Burman. It is actually a little bit hard even to draw
the inference because there was a huge amount of economic
stimulus, not just the tax cuts. There has been a lot of
spending over the last 6 years. It is actually a little bit
hard to draw the inference about what the independent
contribution of that stimulus was to the economy when you
consider that the Federal Reserve, at the same time, was also
trying to keep the economy on an even keel.
It certainly is right that there are other factors that are
very important and the concern is that if we don't pay for the
deficits that have come as a result of the tax cuts, through
cuts in government programs or something like that, then the
long-term effect could be higher interest rates and people
could be spending a lot more on their mortgages and on buying
cars.
Mr. Baird. Let me follow up on that one question, and if
you want to elaborate on the earlier one too. I am kind of
interrupting myself. You used an interesting phrase. The
deficits that come as a result of the tax cuts, would the three
of you concur at least a portion of the current deficit or
recent deficits are resulting from the tax cuts rather than the
tax cuts lowering the deficit?
Mr. Burman. I certainly would concur. Actually to clarify,
the tax cuts are not the only cause.
Mr. Baird. I agree entirely. Mr. Diamond.
Mr. Diamond. I concur. There are several things that figure
into the increased deficits.
Mr. Baird. But the tax cuts are part of it rather than
reducing the deficits?
Mr. Diamond. Absolutely.
Mr. Baird. Dr. Eakin.
Mr. Holtz-Eakin. Certainly tax cuts don't pay for
themselves. So it certainly has to be true.
Mr. Baird. I believe that we ought to use some form of
dynamics. I concur with Mr. Barrett and others, I think the
more about information you can give us about the effects of our
actions, the better off we are. I think we would be naive to
assume, if the mock up of the budget deficit that we are going
to have dynamic scoring rescue us, because every tax cut is
going to generate more revenue, which I tend to hear from
folks, and I think it may be uninformed and it may be naive. Is
there merit also to the dynamic scoring of spending? And let me
give you an example. I got an $80,000 appropriation for a
little theater in a defunct logging town, that has revitalized
that town to measures you can't imagine. It has leveraged
donations of wood from the timber company. The communities come
together. They have got a steam locomotive bringing tourists up
there, $80,000 has generated a tremendous amount of economic
activity. Is there merit to dynamic scoring of spending?
Mr. Holtz-Eakin. I think in principle, you want to look at
both sides of the budget when you do this. I think that is
inescapable. I think the key is to step back from all the
rhetoric that has surrounded this. This isn't a gimmick. It is
not a way to evaluate things based on the budgetary outcomes.
That is a terrible way to evaluate policies. You evaluate
policies by their impact on the overall well-being of the
citizens of the United States. What this does is allow a
particular channel of economic growth to enter into the formal
measures of the costs, and I think it is entirely desirable to
discriminate between good and bad fiscal policies on those
grounds. Paying for themselves is a different game. And that is
not really what this is about.
Mr. Diamond. I stated in my testimony that we should do
both taxes and spending, and partly because I would be a little
worried the example--I mean, that is $80,000 that probably did
increase growth in that area, obviously, but that is $80,000
that was taken from other areas. So we may have seen reduced
growth there. So the national impact may have been a zero. But
we are not sure. It would depend, and we would have to look at
that.
Mr. Baird. Yeah. We would have the $220 million bridge in
Alaska minus $80,000. So we will have to struggle through up
there.
Mr. Burman. I think there are a lot of examples of spending
that can enhance growth, like well-designed increases in
education, research, or infrastructure. But the example of the
bridge in Alaska points out that are some bad infrastructure
investments as well.
Mr. Baird. I thank the chairman and thank the panelists.
Mr. Crenshaw. Mr. Chocola.
Mr. Chocola. Thank you, Mr. Chairman. Thank you all for
being here today. I haven't been here that long. I am in my
second term and I was in the corporate world before I came to
Washington, and I am still trying to sort out the differences
sometimes. Maybe you all could help me today a little bit. We
used to engage in analysis of spending and revenue, policies
and practices, things like capital expenditures, things like
our pricing policy. We went through analysis, but we didn't
talk in the terms of static or dynamic.
We were just trying to figure out what the world was going
to look like after we did what we were thinking about doing. If
we were thinking about a price increase, we would think about
the behavior of our customers, behavior of our competitors, and
what would it do to our volume, our pricing, our cost, our
margins, what it would do to our ability to buy stuff. What
were we doing? Were we engaged in static or dynamic analysis?
Dr. Holtz, you point out that static is not really static. So
what were we doing? Was it static or dynamic?
Mr. Holtz-Eakin. You are trying to look at your future in
the presence of one set of policies versus another, and that is
a--that is the nature of doing a ``corporate score of
alternative marketing policies'' or whatever it might be. It
would be a full-blown dynamic analysis from the point of view
of the corporations, the kind of thing that we have talked
about today. Just in case you are not clear exactly the
differences, I doubt your corporate world had the power to tax
or print money.
Mr. Chocola. No, we did not. But we were trying--we were
trying to determine the outcome of behavior, outcome of
decisions, and so I guess, you know, that my question is, can
we learn anything from the corporate world? We weren't as big
as the Federal Government, obviously, but there are huge
corporations that have to make these decisions based on real-
world consequences. And can we learn from Microsoft or the way
they analyze capital expenditures or their pricing policies?
Mr. Holtz-Eakin. It depends, I think, what you mean by
``can we learn.'' certainly, everyone who is involved in the
policy analysis business, whether it is within the government
or beyond learns enormously by looking at the kinds of things
that corporations do, looking at their investment strategies,
looking at their research strategies, trying to understand how
they respond to different environments, how they, in fact,
would innovate when given different pressures, whether they
come from policies or not.
The difference is private firms are using their own or
their shareholders' money and if they fail, they go away. That
is not true of the government. And so, to full-scale import a
corporate policy evaluation framework into the government is
actually not appropriate. This isn't a corporation. This is a
different entity. It has different powers, and it has different
metrics by which it evaluates success because it doesn't go out
of business.
Mr. Chocola. Well, the reason they would go away, there is
lots of reasons but one, they are making bad decisions which
are bad investments or bad--they don't generate the revenue
they estimate or they are acting unethically or essentially
they are making bad decisions based on bad information. You
know, I think what we are here to do today is to figure out,
how do we get the best information so we can make the best
decisions and implement the best policies?
So from that standpoint, because there is less--maybe more
severe consequences in the corporate world than there is in
government sometimes, isn't there a way that we could learn
from the analyses they use?
Mr. Holtz-Eakin. I think you said it best when you said you
want to bring all the information in the best form to the
process, and my cautionary note to this, you know, as the one
who really believes you can do this, I think I am relatively
unique in that I actually believe you can do dynamic scoring
and learn something from it on a regular basis. You just have
to be careful about what you think you are going to get back. I
don't think you will get more accuracy. I don't think that is
the primary objective. I think you will get to discriminate
between better and worse policies more clearly and you will
know them when you see them. But because legislation takes
place at different points in the year and the economy is always
changing, you are doomed to inaccuracy.
So given you are doomed to inaccuracy, I would place the
premium on knowing a good policy when you see someone,
regardless of when it is enacted.
Mr. Chocola. Well, we always knew we were wrong. We always
knew. But painfully, it is the question of, how wrong are you?
And so, you know, I guess my question is, is there--well, let
me ask, is there a dynamic model that is even close to being
accepted in the analysis world?
Mr. Holtz-Eakin. Yours? I think there are multiple--I think
the issue is that if you put at this table a sort of a broad
range of the American Economic Association, I actually don't
recommend that you do this, but if you imagine doing that, you
could find three consensus models, getting down to one would be
hard, and it would be, in fact, I think the primary
responsibility of the budget committees to make a decision
about how to bring the information from those three models down
to a single number.
Mr. Chocola. And the only way you are going to do that is
trying it and see which one works the best. Right? Mr. Diamond,
we are out of time.
Mr. Diamond. Even then, trying them and seeing which one,
someone who works with the models often don't know what works
the best. I mean, you know, often I am in positions where you
are just--you just don't have any information. But I agree with
Dr. Holtz-Eakin there, there are basically three models out
there that are considered.
Mr. Chocola. You have to do the analysis and then do some
kind of post analysis what you thought happen, did that happen,
right?
Mr. Diamond. That is correct. It may be that--that the
model, the best model changes with--depending on where you are
in the business cycle and what policy you are looking at. So in
2001 and 2003, I think what JCT calls their meg model, was
probably a very reasonable model because they could build in
unemployment into the baseline. Currently, if you were to do
something, I think--and then again, so you have to even ask, do
you want to do short run versus long run effects or not? So all
of these questions kind of bear on which model you choose. I am
not sure it is an open-closed answer. Even if you used one
model and it does well one time, that doesn't mean it will do
well next time necessarily.
Mr. Crenshaw. Mr. Diaz-Balart.
Mr. Diaz-Balart. Thank you, Mr. Chairman. It is wonderful
having this distinguished panel here. Doctor, it is always good
to see you here, and Mr. Neal always has the ability to put
things in real basic terms and I am going to give him credit I
am going to try to do those things as well. One of the things
we always forget when we are dealing with taxes is, we always
talk about the effect on government, which is essential,
obviously.
We don't talk about the effect on the guy who pays the
bill, on the taxpayer. So I want to, following Mr. Neal's
model, first ask some pretty basic questions. Tax increases are
paid for by government or are they paid for by the taxpayer?
Who pays the taxes for tax increases? It is a pretty basic
question. I know. I am following Mr. Neal.
Mr. Burman. Taxpayers.
Mr. Diaz-Balart. Right. And when a taxpayer is asked to pay
more money, it is not voluntary, right? I mean when the
government says we are going to increase your taxes, it is not
voluntary. That is correct. Third, and again, following kind of
Mr. Neal's questions, does Congress has obviously the
constitutional ability to raise taxes massively or small or
increase taxes. So my question is, for example, when
Congresswoman Pelosi and the ranking member of Ways and Means,
Mr. Rangel, supported and went to the floor and voted for a
half-trillion dollar increase on taxes which were paid for by
the taxpayer, if they got the votes, they would be able to do
that, they could do that, right? Congress could do that if they
got the votes. They could increase taxes by a half-trillion
dollars. Who would pay those increases? Taxpayers?
OK. Do we--and by the way, I mention that because that, in
fact, was a proposal that was voted for by many on the floor of
the House. So this is not theory. So in other words, if Ms.
Pelosi was on the majority, Mr. Rangel, chair of Ways and
Means, they could possibly then, if they got the majority, pass
the proposal that they supported and voted for to increase the
taxes on the American taxpayer by half a trillion dollars which
just to put in perspective here with my colleagues is more
money than the yearly expenditures of every single government
in Latin America plus the Caribbean combined.
Or to put it in a different way, is more money than the
expenditures of 1 year of the government of Communist China. So
they could, right, constitutionally, if they had the votes,
pass such a tax increase as they proposed--as they voted for on
the House floor, correct?
Mr. Diamond. Correct.
Mr. Diaz-Balart. Now here is my question. When we are
looking at dynamic scoring, do we ever look at the impact on--
not the government which is essential, that is what we do. Do
we ever look at the impact on the taxpayer, on the family as
to--if we take out from--if we take away from them more money,
how does that impact their decisions, their ability to pay
their bills, their ability to send kids to school, their
ability--do we look at that at all when we look at taxing?
Mr. Holtz-Eakin. Absolutely. The mechanics of doing a
dynamic score would require anyone who doing it to first look
at the policy of the tax increase in this case, look at how it
impacts households and firms and all their decisions, did they
work, did they save, did they spend money, on what and the
feedback that has on economic growth and the overall collection
of receipts and spending at the Federal lever. So it is
embedded in there.
Mr. Diaz-Balart. So do we do that now? Do we do that now
though?
Mr. Holtz-Eakin. We do it now to a certain degree. But
again, we stop--in the mechanics of it, you would never let any
policy change the total level of the economic growth off of the
baseline. That is the conventional scoring at the moment.
Mr. Burman. Distributional analysis from the Treasury,
Joint Committee on Taxation, and the Tax Policy Center,
periodically show the distribution of tax changes as a result
of particular legislation. I think one important point is that
the tax increase by itself doesn't actually affect the long-
term obligations of American taxpayers. What determines those
is the level of spending. If we are financing current spending
from deficits, that just means that we haven't specified to who
is actually going to pay for it. If we are running a $500
billion deficit now, then the implicit payer of the taxes might
be my children or my grandchildren unless you come up with a
way to cut spending to offset the deficit.
In some ways, these distributional analyses are very
misleading when we are running deficits because they don't
present a complete picture of who is bearing the burden. We are
basically accepting the notion that the tax or spending we are
not paying for right now effectively is never going to be paid
for.
Mr. Diaz-Balart. Thank you. Thank you.
Mr. Crenshaw. Mr. Wicker.
Mr. Wicker. Thank you, Chairman Crenshaw. Dr. Holtz-Eakin,
we have a pretty good little briefing prepared by the committee
staff here, and it, of course, defines static analysis for us.
And then it talks about the distinction between dynamic scoring
and dynamic analysis. You weren't with CBO in 1997, but maybe
you remember or maybe somebody else on the panel does.
In 1997 Congress cut taxes by about $89 billion over 5
years and yet tax revenue the next year increased from 19.3
percent of GDP to 20 percent. And for the time being there, the
budget was balanced even though we cut taxes. How would--in
very practical terms that even a congressman could understand,
how would static scoring apply to that one example? And then
what would be the distinction between dynamic scoring in that
1997 tax cut of $89 billion and dynamic analysis?
Mr. Holtz-Eakin. Well, on scoring versus analysis, I am not
going to pretend that everybody accepts these definitions, but
I think of the difference being analysis is focused on economic
performance. You do a dynamic analysis to see how fiscal policy
affects the U.S. economy, it is going to grow faster or slower,
and you might want to expand the scope to take account of--
within the U.S. economy, different kinds of households rich,
poor, savers, old, young, whatever, so you can break it apart
in pieces too, but the basic issue is you look at economic
performance.
Scoring is about taking that economic performance, better
or worse, whatever you are looking at and saying, OK, well if
the economy is doing better, we are going to, perhaps, spend
less on unemployment insurance when it goes down, collect more
on tax revenue whether it is from corporate source or
individual sources, receipts go up, let's calculate the size of
that impact and look at the net impact on the Federal budget,
both the direct tax cut plus the offsets that you might get----
Mr. Wicker. And coming to a number.
Mr. Holtz-Eakin. And putting a number on it.
Mr. Wicker. The problem is this. Mr. Chocola and the panel
had a nice discussion about how we know we are going to be
wrong, it is just a question of who is going to be closer, and
when we are making decisions, oftentimes we are constrained by
the scoring. We believe in our hearts based on experience and
intuition and everything that is available to us that this
would be good policy.
We can't do it because somebody counting beans in some
office somewhere says it scores as costing more than you could
do under this particular budget constraint that we have.
Mr. Holtz-Eakin. Well, as a former chief bean counter, let
me just sort of point out how I think about this, which I think
is important. If you go to this table that was put out there--
--
Mr. Wicker. Table three?
Mr. Holtz-Eakin. Table three was passed out. I am just
eyeballing the three GNP effects. If you go from column 1 to
column 2, you always go up. If you go from column 2 to column 3
you always go down. So if you asked me the question, which tax
policy in a dynamic scoring setting has the better long run
impacts, I would pick the one that goes from column 1 to column
2 over the one that goes from column 2 to column 3. And that is
true regardless of whether you use a future government
consumption offset of a future index offset. So if you have a
floor debate between going 1 to 2 or 2 to 3, and you go to the
bean counters, the bean counters are always going to give you a
ranking that is the same.
So that is point No. 1 and on that, I think that is the
merit involved, it ranks proposals in a particular way. Second
question is, well, is it really point 7 and it is up or is it
really, you know, zero between 1 and 2? Well, you know, that is
where the uncertainty arises, and you know, I say this
lovingly, one of the reasons you get elected is you get to make
the tough decisions, whether or not it is a good idea. And I am
sympathetic, but the scoring system is not primarily to tell
Congress what the outcome will be. It is to tell Congress the
difference between this representative's proposal and this
representative's proposal. That takes primary responsibility. I
would love it if it was simultaneously exactly accurate about
one versus the other, but I don't think that is feasible, not
about the way the business is being done.
Mr. Wicker. Thank you. Well, if there is no one else
waiting, could I perhaps have another second or two Mr.
Chairman?
Mr. Crenshaw. Sure.
Mr. Wicker. Tax cuts don't pay for themselves. Everybody on
the panel agrees. And it seems that our briefing from the
committee agrees that no credible economist really believes
that tax reductions could generate enough revenue through
revenue growth to fully compensate for the tax reduction. Now,
``fully'' is a very important word there. And I guess this is
what dynamic scoring is all about. In the example that I gave
you where we cut taxes by $89 billion over 5 years but revenue
increased, would anybody here suggest that the tax cuts had
nothing whatever to do with revenues increasing?
Mr. Diamond. I wouldn't. I mean, I would--knowing at least
part of the 97 tax cuts were capital gains related, I think you
could look at column one and say that that is one proposal that
probably pays for more of itself but not fully.
Mr. Wicker. So tax cuts don't fully pay for themselves but
they can partially pay for themselves.
Mr. Diamond. That is correct.
Mr. Wicker. And that is the problem with static scoring, is
static scoring assumes it is just a total loss of revenue.
Mr. Burman. Correct. But for some tax cuts as Dr. Holtz-
Eakin and Professor Diamond have pointed out, the dynamic costs
are actually larger than the static costs. Even in the case of
capital gains, there are complications. The problem is that
with capital gains the difference between tax rate and capital
gains and other income is exploited by everybody designing a
tax shelter. When you make that difference larger, there will
be more tax sheltering activity and that kind of thing doesn't
show up in these dynamic models because it is just very hard to
represent.
So the issues are complicated, but it is certainly true
that for a lot of kinds of tax cuts, there would be general
agreement that behavioral effects would be positive, especially
if they were paid for.
Mr. Wicker. Well, the chairman has been very indulgent on
me with the time. Let me just observe in following up on Mr.
Barrett's question. It would seem to me that somewhere in the
public record of the debate back in 1997, some entity somewhere
in the private sector perhaps tried to do a dynamic score of
the statute and the tax cut that the Congress enacted, and I
would be interested if somewhere out there someone within the
sound of my voice could discover if a dynamic score was urged
upon the powers that be and how accurate it turned out to be as
opposed to the scoring that we actually received. Thank you,
Mr. Chairman.
Mr. Crenshaw. Thank you. Mr. Cuellar, do you have any
questions?
Mr. Cuellar. Not at this time. Thank you, Mr. Chairman.
Mr. Crenshaw. Would you put the chart back up because to
follow up on a couple of questions Mr. Wicker asked, when you
talk about dynamic analysis, one of the things when we looked
earlier, when you argue about do tax cuts pay for themselves,
and I think most people say they don't in full, but somehow
that if you don't tax overtime, wages, people might work more
overtime and that might--I mean, that might change the dynamic.
I think it has been pointed out there are relatively few
situations where dynamic analysis would really be useful, but
one of them would be these capital gains and the ordinary
rates. And it seems to me that the one thing that stands out
when--when you make that offsetting decision, when you look at
that last column of number 3, when you say if you decide you
are going to control spending as an offset so to speak, you end
up saying the economy is going to grow by .7 percent, and if
you say you are going to use the offset of raising taxes, you
find in accordance with that dynamic analysis that the economy
loses .9 percent.
Now, if that is a dynamic analysis, is that legitimate? I
mean, do you all agree? I mean, I think Mr. Diamond, that he
was involved in the analysis, might say that that is true, but
does anybody disagree when you make those kind of assumptions
that you--that you can get the result that is on that screen?
Maybe start with Mr. Burman, because he might not think so.
Mr. Burman. I am skeptical of the actual point estimate. I
agree that the dynamic analysis is helpful for ranking
different options, but these models require so many
simplifications, so many assumptions about how people respond,
incentives to work and save, about what time period people make
decisions over that I think that the sensitivity of these
results to the assumptions can be really extreme. People who
build these models, like Professor Diamond, tried the
sensitivity analysis and they show that there is a range of
outcomes. CBO has done this in other contexts as well and that
is very helpful, but the point estimate itself is what I am
fairly skeptical of.
Mr. Diamond. I assumed you agreed with the analysis.
Mr. Crenshaw. Let him answer last and see what kind of----
Mr. Holtz-Eakin. I think the primary pieces that go into
long-run growth, to make the economy bigger, you either have to
have more stuff in the way of people, more stuff in the way of
buildings and factories, or more stuff in the way of
technologies, and the only way you get the latter two of those,
you give up something now, you make an investment, and so the
key to long-term growth is saving, and these policies which cut
government consumption, means the country saves more. You have
to get this answer.
Mr. Crenshaw. Mr. Diamond.
Mr. Diamond. I will start out by just touching on one point
Dr. Burman made, and that is that the OTA provided two other
tables it provided for low and high parameter runs. And then I
would just point out the result and kind of what you are
getting there is you can see when you are going across from
columns 1 to 3 that when you go from column 2 to column 3,
adding in the remaining tax cut provisions, which were the
child credit, the increased standard deductions and bracket
width for married filers and the 10 percent rate bracket which
are all somewhat or inframarginal for most taxpayers, meaning
they are not going to have any of these behavioral effects that
we talked about with dynamic analysis labor increases and so
forth, in fact they may have the opposite.
You can see that real GNP, the increase or predicted
increase in real GNP drops from 1.1 to 1.7 percent. What
happens now when you go down now to the future income taxes
now, you are having these extra tax cuts but instead of
offsetting them with decreases in government consumption, you
are raising taxes on waiver income and capital income. So you
are getting this magnified effect because now you have actually
increased capital income taxes as opposed to lowering them
because the tax cut for the child credit, the marriage penalty
relief and the 10 percent rate bracket, that has been paid for
through an increase in capital income taxes and labor income
taxes, and that is why that result is so kind of substantial.
And that is all I have to say.
Mr. Crenshaw. Thank you.
Mr. Baird. Mr. Chairman? When you get a chance, you may
have more questions, if I could ask.
Mr. Crenshaw. Go ahead. And then I have one final one.
Baird.
Mr. Baird. Just two quick questions, follow up on Mr. Diaz-
Balart's comments, and I think Mr. Burman alluded to this. It
is true that people pay the taxes, that is where the money
comes from. Who will pay for the deficit?
Mr. Burman. Well, that is the big problem. We haven't
specified how we are going to close the deficit. It might be
higher taxes on our children. It might be cuts in spending
programs, which depending on what we are cutting could have big
or small effects on the economy. The spending programs
presumably benefit people as well, so cutting those would have
a cost. The problem with deficit financing is that we really
don't know what the debt effects are going to be.
Mr. Baird. Who pays--so it will be the people who will pay
for the deficit at some point?
Mr. Diamond. I mean, currently, we are all paying for it in
that every year we make an interest payment.
Mr. Baird. You read my mind. That was going to be my next.
Mr. Diamond. Then also, eventually you have to pay it off.
It is the principle interest question. We are all currently
paying interest. At some point, someone will have to pay the
principle.
Mr. Wicker. Will the gentleman yield on that?
Mr. Baird. Sure.
Mr. Wicker. We are just speaking hypothetically here, and I
would like to balance the budget and have advocated a balanced
budget. But Dr. Diamond, you just said eventually you would
have to pay it off. Corporations don't eventually pay off their
debt. They roll it over. And I have heard economists say, we
realistically will never pay down the public debt. We hope that
it is within a manageable percentage of GDP, but what says that
this country will eventually have to pay off the public debt?
And if so, when?
Mr. Diamond. You don't have to pay off the principle. You
can continue to make interest payments forever.
Mr. Wicker. Which is just what corporations----
Mr. Diamond. They often--I mean they have often rolled over
one piece of debt for a new piece of debt.
Mr. Wicker. Bonds.
Mr. Diamond. I agree with you. You don't have to pay it
off, but you are still paying the costs through the interest
payments and I agree that as long as GDP is growing faster than
the government debt, then in some sense, you are actually
getting more wealthy. I mean even though you have more debt
stacking up, if your income is going up faster than your debt,
I mean these are the types of things that we should look at.
Mr. Wicker. Indeed. If Donald Trump owes a million dollars,
it is not quite as severe as Roger Wicker owing a million
dollars.
Mr. Diamond. But whether we are going to pay it off or not,
there is still a cost.
Mr. Wicker. There is a cost, no question.
Mr. Baird. I will reclaim my time. But Mr. Holtz-Eakin may
want to respond to Mr. Wicker.
Mr. Holtz-Eakin. Just in the context of the question at
hand which is the dynamic analysis issue, I think it is
important to recognize that what is going on here is that
taxpayers pay, bear the burden of a policy by having a lower
ability to finance their private lifestyles because of the
decisions made in the fiscal policy. And so, you know, my case,
all I care about is Diet Coke and Twizzlers and when I pay
taxes, I can't get as much of either. And what the dynamic
scoring would show for you, if you showed a tax financed or a
deficit financed, whatever your fiscal policy was for a given
level of spending, it would affect the growth in the economy.
I mean, somewhere out there in some future generation, they
might pay for it by having a less productive economy and less
GDP and that is one way that the burden of particular spending
policies gets inflicted on the private sector.
So one of the things dynamic scoring would allow you to do
would be to compare what is the impact of paying for it all now
with taxes versus paying half of it now with taxes and doing it
later and showing to the extent you care about it, the
distribution across generations because there are different
ways to shift this off to the future and slower economic growth
is, in fact, one of them.
Mr. Baird. Two points that I want to follow up on. I have
looked at the OMB budget figures every year, and one of the
things that strikes me is we are all committed to cutting
waste, fraud, and abuse. That is given, and I think we ought to
eliminate it. But that won't solve the problem. As I looked at
the budget deficit figures last year unless I am mistaken and
actually has been the case for the last 4 or 5 years since I
have been here, actually, the nondefense discretionary spending
is less than the size of the Federal budget deficit if you
include borrowing from Social Security in the budget deficit
figure and you include spending on Iraq.
In other words, if you--when we look at this chart you had
up in decreasing future government consumption, if you
completely eliminate nondefense discretionary spending, you are
still in deficit. So you shut down the Federal prisons, you
open up the borders, you shut down the national parks, you
eliminate the Department of Education, some of these people may
like, some people may not like but you are ending the whole
show, except for defense and the mandatory programs.
I will be the first to admit we have to deal with the
mandatory spending side. We just have to do that, and frankly
neither side has shown a great deal of courage in that regard.
But this notion that--when we put here, decreasing future
government consumption. Pretty easy to put down. Pretty hard to
implement. When you put this statement here, do we have an idea
of what that would look like, decreasing future government
consumption, by what amount and where?
Mr. Diamond. I mean, you definitely could have that idea
and that may be another important aspect of dynamic analysis to
give members what that would look like, to give some examples
of what that would look like. That could be done. I don't have
any of the numbers with me, but that could be done.
Mr. Holtz-Eakin. Just to beat a dead horse, I don't think
it is imperative how that gets done. I think it is imperative
if you are looking at policy choices now, they are on a level
playing field. If you are going to specify an unrealistic,
hypothetical, politically unattainable cut in government
consumption for all policies in the future, then they are on a
level playing field and that is fine.
So for the future of actually doing an analysis, you don't
have to specify where to get the votes in 2080. You just have
to make sure everyone gets the same treatment.
Mr. Baird. I would argue it is easier because it is easier
to say theoretically we are going to cut government spending
than it is to say we are going to deal with the deficit through
taxes because the taxes come straight out of your pocket so
there is an inequality there in the underlying assumption.
You just say cut waste, fraud and abuse and we will solve
the problem. First is you may have to suck it up and pay a
little bit for the services you are receiving today in order so
you don't pass the deficit on to your kids. The point I would
be making is yes in the abstract, you are giving us the numbers
how they turned out but the political reality and the day-to-
day reality for the taxpayers and those who elect to who
represent them is different.
The final question I would just ask is I heard this issue
about debt and deficit is a percentage of GDP. And in theory, I
understand the concept, but here is the problem, I think there
is a huge disconnect happening right now relative to prior
times in which we have achieved debt at a comparable level of
percentage of GDP. And here is the disconnect. In the past, and
I have looked at the chart over the fluctuation of deficit and
debt as a percent of GDP, the baby boom generation was paying
in in the form of taxes, not drawing out. That would be point
one.
And point two is, we were not competing against 1.3 billion
Chinese and 1 billion Indians and hundreds of million of people
in Indonesia. I think there is an enormous historical
disconnect and we are kidding ourselves if we think that we can
carry the same deficit percentage GDP ratio now that we have
carried in the past without any long-term consequences. Any
comment on that?
Mr. Holtz-Eakin. Well, I would concur that you really
should be looking forward all the time, not looking back. And
if the budget was balanced today, we would still have a big
problem if we don't change Social Security, Medicare and
Medicaid so looking forward and recognizing the demographic
shift is imperative, and in looking forward, you are going to
face an international economic arena that is very different
than in the past and policies better reflect that or we will
not be well served.
Mr. Burman. My view is that, just looking at the
demographics, if you can't figure out what to do with Social
Security Medicare and Medicaid right now, the next best thing
would be not adding on to the national debt. The lower the debt
is 10 years from now, the more able our children will be to
deal with these problems that we have pushed off to them. By
contrast, if we pile onto the debt and it is larger, it is
going to require much higher taxes to bring things in the
balance and much more draconian cuts in programs and they are
not going to be any easier when there are twice as many people
in AARP as there are now.
Mr. Diamond. I agree with what they said. To be an
optimist, hopefully the growth in China will expand our market
more so than just--there is going to be a mutual gain there. So
it is not always--one to one. That ignores a lot of questions
about security and dangers and all that stuff. We will leave
for----
Mr. Baird. Well, I guess that $64 billion a month trade
deficit, that is a fairly optimistic scenario, but I thank the
gentleman for the comments.
Mr. Crenshaw. Let me ask you just two final questions, and
Mr. Wicker has another question. And one, Dr. Holtz-Eakin, when
I asked you earlier about the legislation that kind of prompted
this discussion, the modernization of all these concepts you
said it was necessary appropriate and timely, could you give us
a couple of examples of where, you know, where changes need to
be made? In other words, for instance, like the pension benefit
guarantee corporation, kind of public-private partnership, I
mean, they didn't have one of those in 1967, and--but a couple
of examples like that of how, you know, how modernizing the
concepts might help us get a better handle on what is revenue,
what is expenses, just one or two that you encountered when you
were head of CBO.
Mr. Holtz-Eakin. Well, certainly the PBGC is No. 1 on my
list. The statutory language says that the taxpayers are not at
risk if the PBGC runs out of assets to pay off pension
insurance. I don't believe anyone in this room thinks the
Congress would stand back and let that happen. So the taxpayer
is at risk. The budget doesn't reflect that at all because the
budget has a very strange treatment of the PBGC where premiums
are counted in and actual benefits are paid out, but if someone
puts a pension plan in the PBGC, there is no change in the
budget immediately of the recognition that we will pay out more
in the future.
If it is a government program, put it on the budget
completely. If it is really not and the taxpayers is not at
risk, then get all the treatment off, but currently, it is a
little halfway house, and that is, I think, misleading and not
appropriate.
So that is No. 1. Another one that came up recently has
been the Universal Service Fund, which, when it was created,
some people believed was not going to be reflecting the Federal
budget, but, in fact, it uses the sovereign powers of the
Federal Government to collect revenues from telecommunications
companies and use them for particular policy purposes, so it is
reflected on the Federal budget.
The fact that it wasn't expected to be on the budget by
some parties led them to behave in ways that are inconsistent
with standard budget treatment, and that has been sorted out
over the years. Well, that is another example where, you know,
the lines need to be drawn about what is in and what is out and
just get business clarified. For those who are in and in a big
and important part of the Federal Government now are financial
transactions, whether they be loan guarantees or direct loans
or some sort of investment activities, venture capital
activities, how do you treat all these financial transactions
and appropriately reflect the taxpayers' exposure to additional
taxes to meet those obligations? That is a very important
question. Financial arrangements have gotten increasingly
intricate. When you bought something versus leased it is not
obvious. When you have made a guarantee versus a loan is not
obvious. There is a lot of work that would be beneficial in
clarifying exactly what it is that is on the books at any point
in time.
Mr. Crenshaw. I thank you. Did either one of you all have a
comment to make in that regard? Thank you. And the last
question now I would ask, is as we kind of go through this
exercise of talking about--I think it is helpful to understand
that static score and actually has a little more dynamism in it
that might be thought, and yet dynamic analysis is a pretty
broad overarching concept that would be helpful probably in a
handful of situations. Would each of you all comment on what
role the Budget Committee might play? Because you have got JCT,
you have got CBO and where--where and how can the Budget
Committee fit in to kind of making this a better way to analyze
spending, analyze taxes? Any thoughts on that?
Mr. Diamond. As I pointed out in my testimony, I think the
current House Rule 13 is a decent place to start, and that
maybe going from there, we should just try to have the analysis
done in a more timely fashion and it should be done on spending
and taxes and that we should avoid--I mean, we are going to
have to limit what it is done on, otherwise, there is just not
the staff resources to do it, although there is a very
competent staff in place, you have got to limit those choices,
and that needs to be done in a way that is not done with a
political bias, it needs to be done from kind of an
observer's--an unbiased observer's point of view, and then
last, I guess is just being educated. I think back to the Fed
model. The Fed does use all these models, and they do use
macroeconomic analysis, and I guess it is a little easier
because some of them are economists, they don't necessarily
have the technical expertise, but to some extent I think just
being more involved, especially, you know, maybe telling us
what you want to see without--without forcing us to give any
one certain thing or exclude--without forcing any exclusion of
information.
Mr. Burman. I had a couple of examples in my testimony of
ways I thought the budget process could be improved. One issue
was that we actually don't do a very good job of forecasting
the baseline. And there is some evidence from Professor Alan
Auerbach of Berkeley that information is not incorporated in
the forecast. The errors tend to be correlated over time.
Forecasters consistently overestimate the deficits for a
period, and then consistently underestimate deficits after
that.
He didn't figure out exactly how to exploit that
information to make the forecast better, but it might be
worthwhile to invest a fair amount of time thinking about
whether there is sort of a systematic bias in the whole process
of forecasting the baseline and whether we could eliminate it
or use information from year to year to help us to retarget the
baseline and do a better job of forecasting going forward.
There are a number of little things. One example is that on the
tax side, unlike on the budget side, we don't do probabilistic
scoring and that produces legislation that looks like it
doesn't cost anything, but it clearly has value.
An example in my testimony is that there is a tax credit
for low-yielding oil and gas wells and it only kicks in if the
price goes below a certain level. That score is costing nothing
because that level is below the level that was prevailing when
the legislation was put in place. But there is an enormous
lobbying effort for this provision. So clearly some people
thought it was going to be of some value under some
circumstances, and the right answer would be, just as on the
spending side, to include the expected costs to the government
across the range of prices, and not just the point estimate of
what you expect given a set price.
Mr. Holtz-Eakin. I think there is an important role for the
Budget Committee. First of all, given the state--not just the
scientific knowledge, but the overall understanding and
acceptance of these dynamic techniques, I think it remains
appropriate for them to be supplemental at this point and not
the major way of doing business, but they should be regularized
and the Budget Committee can take the lead in doing that. And
the Budget Committee then would have an important educational
role to help members understand what it is that would come out
of such an analysis and how it would differ from current
practice, and that is the first and foremost role.
The second one is if it were the case that this would be
brought formally into the budget process, it has to be the
Budget Committee who is ultimately the guardian of what scores
get entered into the budget that makes the call on when a
dynamic analysis is done. You know, as I stress, not every
piece of legislation merits this. And it would be a terrible
misuse of resources to crank up big models for tiny proposals,
but you can't leave it to the judgment of the CBO or the joint
committee or somebody when they are going to do it or it is
going to be perceived as a political call and that is going to
undermine the entire effort.
So there has to be a call made at a higher level on the
circumstances in which dynamic analysis would be employed. That
is an important consideration. The Budget Committee would have
to weigh in heavily there and they would also have necessary
the coordination issue between the joint committee and the CBO
because of the ability to disband both sides of tax and
spending aspects of the budget. I think those are crucial to
think about.
I just want to close by disagreeing somewhat with Mr.
Burman, who I otherwise respect greatly, especially since he is
so much taller and funnier than I am. I don't think this is
going to be an issue getting the baseline more accurate. A
while back, the Federal Reserve staff put out a study which I
found very informative. It compared the CBO projections, which
have a particular set of handcuffs on them which are called
current law, they project under current law and they compared
them with the OMB forecast which have a different set of
handcuffs, which the president's policies are fully embedded in
those forecasts and then the third player, the Federal Reserve
who, you know, we are all jealous of because there is no
handcuffs, they get to just project what they think will
happen.
The Federal Reserve was more accurate by 1 percentage point
over a 1-year horizon in forecasting the deficit and after that
it was a wash. They were all wrong, and I think that tells you
it will be very difficult to make dramatic improvements in
budget forecast especially on the deficit, and that is not a
good place to spend time and energy. It is just something that
is just hard.
Mr. Crenshaw. Well, thank you very much. No further
questions--one final question.
Mr. Wicker. The President asked for a half million dollars
for the Treasury Department for an Office of Tax Analysis to
create a division for dynamic analysis. Both Appropriations
Committees, House and Senate, have approved this figure. And so
it seems that for the first time, we are actually going to have
a little division within Treasury to do dynamic analysis. Is
this a good idea? And is there a danger of political pressure
being brought to bear on the people within this division? And I
would just like to give each panelist an opportunity to talk
about the merits of this proposal, which seems to be on track.
Mr. Holtz-Eakin. I think it is a good idea. It is a good
idea, No. 1 because, you know, I have a basic endorsement of
the idea of doing this kind of analysis. No. 2, I am very
skeptical of monopolies, and having just the congressional
branch doing it is not a good idea. In my experience of CBO,
every time that the CBO had to explain why it was different
from the administration, whether it was in Social Security or
in Medicare or any other aspect, PBGC, both parties' analyses
were improved by just the simple act of getting together and
trying to figure out why they were different, so I think it is
actually very healthy and constructive for this kind of
capacity to be broadly spread throughout the fiscal policy of
the executive branch and the Congress.
Mr. Diamond. I think it is very useful and I know several
of the people over there, they are not--you know, they are not
out of the mainstream. Very reasonable people and in general my
view of OTA, and I think Lynn will have a much deeper view,
since he was the deputy assistant of OTA, I don't think that is
a real--the staff is, in some sense, nonpartisan in some way,
and they don't--they have some political pressure, but my view
is that they tend to fight it just a little whereas I think the
appointed positions tend to put it on them. But that is--that
is an uneducated view to some extent.
Mr. Burman. I was a deputy assistant secretary of Treasury
heading up the office that would be doing this at the end of
the Clinton administration, and I actually have serious
concerns about this. I should point out that I have enormous
respect for both of my colleagues, both of whom are funnier
than I am, but I disagree on this one issue. The Treasury,
unlike JCT and CBO, is an inherently political organization.
The staff is nonpartisan. The staff is exceptionally good. I
think the analysis that they did recently is a fine analysis,
but there is political pressure in the budget process.
I was at the Treasury Department when we produced baseline
receipts estimates. I can't even remember what was wrong with
the bottom line, but we got a new forecast from the
administration, and we produced a new set of baseline receipts
estimates, and then we got another new forecast from the
administration, and we produced another new baseline receipts
estimates. Many, many broken arms at OMB later, they had their
budget forecast.
I think the effort is duplicative of the work that is done
by JCT and CBO, which are nonpartisan. I think that there is
the pressure for politicization. I don't think the staff would
ever do a bad analysis, but the problem is that the analysis
that would be released would be very, very selective, at least
that is the concern. And it might be that the analysis would
always be above reproach, but I think there would always be a
suspicion that the analysis that came out of the Treasury
Department would be part of Treasury's advancing the
President's agenda, which is what Treasury's role is.
So I think if you actually wanted to have an independent
dynamic analysis division to act as a check on the other
organizations that are doing it, it would be better to put it
somewhere else, like at the Federal Reserve or in an
independent agency.
Mr. Crenshaw. Well, thank you very much for being here
today. Thank you for your testimony. Thank the members. The
meeting is adjourned.
[Whereupon, at 12:01 p.m., the committee was adjourned.]
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