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When Setting Tax Policy, Don’t Forget About Long-Run Growth

Friday, April 11, 2014

Neither party will always welcome estimates of how their proposals affect long-run growth. But the American people should welcome the prospect of their elected representatives being asked to think further ahead than the next election.

Last Friday, the House of Representatives took a sensible step to counteract the short-run focus that too often drives tax and budget policy decisions. The House voted 224-182 to pass H.R. 1874, the Pro-Growth Budgeting Act, which would require the Congressional Budget Office and the Joint Committee on Taxation to analyze the effects of major tax and budget bills on long-run economic growth.

Tax and budget policy can boost economic growth, particularly by cutting tax rates on labor and capital and reducing the deficit. Of course, the promotion of long-run growth can conflict with other goals, such as preserving tax progressivity and the safety net or providing short-run Keynesian demand stimulus. Resolving these tradeoffs sometimes requires hard choices.

Official budget estimates cover only a ten-year period and exclude any effects of tax and spending changes on the size of the overall economy.

Today, however, the deck is stacked against growth-oriented policy. Official budget estimates cover only a ten-year period and exclude any effects of tax and spending changes on the size of the overall economy. Although CBO and JCT have provided supplemental estimates of how a few tax and budget proposals affect the overall economy, even those estimates have been limited to a ten-year period.

H.R. 1874 would offer modest measures to place greater attention on long-run growth. For a handful of the largest tax and budget bills, it would require CBO and JCT, “to the extent practicable,”  to provide supplemental estimates of the bills’ effects on GDP, investment, capital, employment, labor supply, interest rates, and revenue over a 40-year period. Of course, members of Congress would be free to give the estimates as much or as little weight as they saw fit when voting on the bills.

Regrettably, H.R. 1874 provoked partisan division, with Republicans supporting it 220-0 and Democrats opposing it 182-4. A similar bill passed by the House in February 2012 never came to a vote in the Democratic-controlled Senate. Rather than supporting H.R. 1874 as a tool to help both parties make more informed policy decisions, Democrats raised a series of unfounded objections.

One objection emphasized that long-run growth effects are too uncertain to be estimated. But we shouldn’t ignore important economic effects just because we don’t know exactly how large they are, particularly when economic models and statistical studies provide guidance about their approximate size. Short-run Keynesian stimulus effects are also uncertain, but many of those objecting to long-run growth estimates place heavy reliance on CBO’s estimates of those effects.

H.R. 1874 would address legitimate concerns about uncertainty by requiring CBO and JCT to use a variety of models and to detail their assumptions, and by keeping the revenue feedbacks from the growth effects out of the official revenue estimates. Also, before the bill was passed, the House adopted a Democratic-sponsored amendment to require CBO to review the accuracy of the growth estimates.

A bizarre objection alleged that CBO and JCT would exaggerate the growth benefits of tax cuts, perhaps even estimating growth effects so large that tax cuts fully pay for themselves. The notion that CBO and JCT are controlled by supply-side extremists is absurd. In reality, the agencies’ growth estimates have been quite cautious. In line with statistical evidence, they have found that tax cuts almost never fully pay for themselves and that deficit-financed tax cuts often harm rather than help long-run growth.

On a more serious note, Democrats complained about a provision in H.R. 1874 that would exclude growth estimates for discretionary federal programs that receive annual appropriations. They offered an amendment to remove the exclusion, arguing that the growth benefits of education and infrastructure spending would otherwise be overlooked. Republicans voted down that amendment, along with three less serious amendments that would have added unnecessary burdens to the growth estimation. (The silliest amendment would have required separate estimates for the 14,000 census tracts and counties that the Small Business Administration has designated as HUBZones.) Although Democrats are correct that some discretionary programs may boost long-run growth, current economic models and statistical studies offer little guidance about the growth effects of most of the bewildering array of programs. CBO explained the day before the House vote that it lacks the resources and data to provide the additional estimates that the amendments would have required.

Short-run Keynesian stimulus effects are also uncertain, but many of those objecting to long-run growth estimates place heavy reliance on CBO’s estimates of those effects.

H.R. 1874 would exclude growth estimates, not just for discretionary programs, but also for most tax bills – it would require estimates for only a handful of the largest bills. As time goes on and more studies are done, it may become possible to estimate the growth effects of some discretionary programs and a broader range of tax bills.

If H.R. 1874 becomes law, members of Congress may not like some of the growth estimates that they receive – confronting economic reality can be unpleasant. Democrats may be disappointed to see that marginal tax rate cuts are generally better for long-run growth than entitlement benefit increases. Republicans may be disappointed to see that the growth effects of tax cuts are not as large as they have sometimes claimed and that few tax cuts fully pay for themselves. Members of both parties may be disappointed to see that deficit-increasing policies tend to impede long-run growth.

Neither Republicans nor Democrats will always welcome estimates of how their proposals affect long-run growth. But the American people should welcome the prospect of their elected representatives being asked to think further ahead than the next election.

Alan D. Viard is a resident scholar at the American Enterprise Institute.

FURTHER READING: Alex Brill describes how we are “One Step Closer to Tax Reform,” Matthew Jensen contributes “An Honest Account of the Corporate Income Tax,” and Sita Natara Slavov adds “The Penalties of Our Tax Code.”

Image by Dianna Ingram / Bergman Group


 

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