US Tax Panel Urged To Dump 'Static' Revenue-Estimating

by Mike Godfrey, Tax-News.com, Washington

05 October 2005

The Centre for Freedom and Prosperity along with 39 other free-market bodies has written to President Bush to ask him to tell his Advisory Tax Panel to junk 'static' revenue forecasting, which seriously misrepresents the economic effect of tax changes.

The Panel is due to report in early November, after a delay caused by recent hurricanes, and has already announced that it will recommend abolition of the Alternative Tax.

"Static" revenue estimating techniques assume that tax policy changes - regardless of their magnitude - have no impact on the economy's performance. As such, these "official" estimates commonly overstate both the amount of tax revenue that will be generated by tax increases and also exaggerate the amount of revenue the government will "lose"" because of tax rate reductions. This "static" methodology has been widely criticized because it provides policy makers with inaccurate numbers and creates a bias against lower tax rates. Dynamic analysis - sometimes referred to as "reality-based scoring" - acknowledges that taxes do affect the economy. Dynamic scoring recognizes, for instance, that higher tax rates discourage work, saving, and investment, and therefore will not raise the amount of money suggested by static estimates.

Last year, Gregory Mankiw, chief of the White House economic advisory team, unveiled new research showing that tax cuts effectively pay for themselves through increased consumption, investment and growth. Presenting a seminar at the Heritage Foundation, Mankiw described a method of calculating the cost of a tax cut known as ‘dynamic scoring’, which factors in economic growth and the increased income that is likely to ensue from tax cuts, effectively reducing the cost to the government.

The letter is signed by, among others, Grover Norquist of Americans for Tax Reform, John Berthoud of the National Taxpayers Union, and Todd McCracken of the National Small Business Association.

September 28, 2005

The President
The White House
1600 Pennsylvania Avenue, NW
Washington, DC 20500

Dear Mr. President:

We the undersigned share the hope that the work of the President's Advisory Panel on Federal Tax Reform will be of historic value in fundamentally reforming our Nation's moribund federal tax system. We applaud the direction given in your January 7th Executive Order, which ordered the Panel to develop options that "promote long-run economic growth and job creation, and better encourage work effort, saving, and investment ...." However, we have become deeply concerned that this directive is being undercut, and the work of the Panel needlessly compromised, by the use of "static" estimates on reform alternatives.

Economists agree with the basic economic premise that the type of tax reform chosen can profoundly affect our national prosperity. Nevertheless, the revenue neutral rate estimates provided to Panel members by the Office of Tax Analysis (OTA) of the Treasury Department knowingly fail to account for economic growth effects of tax reform alternatives. By failing to consider how the options affect economic growth, such static estimates prevent the Panel from considering how well or how poorly policy options achieve the primary charge on which the Panel's existence is based.

The failure to take dynamic effects into consideration is welcomed by the adversaries of reform, because it supports political rather than scientific ends. Static estimates overestimate revenue gains from tax regimes with steeply progressive rates that doubly and trebly tax savings and investment, and they artificially ensure high revenue neutral rates for the most pro-growth reform alternatives. By systematically providing incorrect or inaccurate information to the Panel, such estimates will hamstring the Panel in its efforts to develop reform proposals that truly benefit the American people. Notwithstanding the protestations of OTA estimators, such estimates can be done, are done regularly in the private sector.

We urge you to direct the Panel to use "dynamic," "reality-based" revenue estimating methodology so that the impact of the tax system on the incentives to work, save and invest is properly considered. We urge you to ensure that the methodology chosen acknowledges the reality that the U.S. economy is an "open" economy where capital can flow to and from the U.S. and where goods and services cross international borders. We urge you as well to direct the Panel to adopt longstanding recommendations of the Council of Economic Advisers, contained in the Economic Report of the President, to measure the distributional impact of tax reform alternatives as a function of taxes paid over lifetime income or consumption. Just as static estimates favor the current regime, distributional measurements of taxes paid over annual income disfavor pro-growth alternatives.

Sincerely,

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