Risky gamble in setting taxes, spending

Chances are good that most people missed a major change in national economic policy last month that could effect everything from taxes to spending.  In other words, your wallet.

The issue is how the government calculates the future effect on both the economy and the government budget of bills proposed in Congress.  Obviously, bills with either a projected positive effect or no effect would have a better chance of becoming law than those imposing added costs.

It boils down to something called “scoring.”  In other words, what’s the economic score, winning or losing, from a piece of legislation?

Scoring is based on the rules of the game.  Just as those running any sport can alter its rules, Congress, too, can change the scoring rules.  In this case, changing the rules of the game can change the game itself

Until January, the Congressional Budget Office, the outfit doing the forecasts, used what is called “static scoring.”  It assumed no change in the economy – it would remain static – when the government raises or lowers federal taxes or government spending.

A simple way of calculating the impact, it simply eliminated the need to study what the effect of a measure would be on the economy.  It would look only at the resulting impact on government revenues and expenses.

If, for example, a tax cut was proposed, static scoring would project how much revenue would be lost.  If spending was boosted, it would forecast how much more revenue was needed.

Static scoring does not provide an accurate picture of future effects.  A tax cut might stimulate the economy, which in turn can increase tax revenues.  While it is unlikely that tax cuts can completely pay for themselves, it is likely that the cost of a tax cut can be reduced by the revenues resulting from increased economic activity.

Different measures would have different effects.  A corporate tax cut would produce a different effect than reducing government outlays used to stimulate the economy.  But static scoring could make them seem equivalent by counting only the amount of dollars in each change and not their long-term economic effect.

Now in control of both houses of Congress, the Republicans have ordered a change in the scoring method.  The new approach is called “dynamic scoring.”

Dynamic scoring will look at the effect on the economy of a proposed change in federal revenues and expenses and try to take into account resulting federal tax gains or losses.  To do this, the proposed change will be run through an economic model of the American economy.

For example, corporations say their federal tax rate is too high, making them less competitive in the world.  What would happen to economic growth, possibly bringing in more federal revenues, if that tax were cut?

The answer obviously depends on the model.  That’s the problem.  Just as static scoring with no complete model did not study economic effects, dynamic scoring can be influenced by the design of the model itself.

The other problem created by using dynamic scoring is that effects must be measured over a span of years.  But much can happen in the future that the CBO cannot possibly know.

Congress itself could tinker with the proposed change, almost inevitable in a tax system under which there are more holes than cheese.  And new ones are added every year.

And what about changes in the economy itself unrelated to the change in government policy?  These now-unknown changes could greatly influence how the policy plays out.

Republicans may justify tax cuts by finding their future impact on the federal budget is less than it might appear.  Democrats won’t agree, because they distrust the model.

The new scoring method is a gamble on the future.  It can allow more tax cuts or more spending, but nobody can be sure of really understanding future effects.

Neither the now abandoned static scoring nor the new dynamic scoring can provide more than a guess about the effect of proposed changes in federal taxes and spending.  But the new approach is somewhat riskier than the old one.

Does the same situation apply in states?  No, because all states except Vermont have some kind of balanced budget requirement.

That means, at the state level, every tax cut or spending increase must be immediately balanced by other measures that keep the budget from falling into a deficit.

While the possible future impacts may influence legislators’ decisions, this is the ultimate in static scoring.  The budget offset is not based on future developments; it exists right from the start.