Congress Just Found a Way to Make Deficits Disappear

One of the first tasks accomplished by the new US congress was tweaking the rules used by Congressional accountants to hide the borrowing caused by tax cuts.

The shift in methods directly reflects the preferences of the new Republican majority in Congress. The new rules require the use of “dynamic scoring” models, which rely on dubious economic theory to suggest that tax cuts pay, at least partially, for themselves. This minimizes the very real conflict between an agenda of tax cuts and one of debt reduction. It’s a bit of political jujitsu—with consequences that could be disastrous for the US budget.

The theory is that lower tax rates will lead to more work, earning, and investment, spurring economic growth that otherwise would be unrealized, absent changes in tax law. An estimate of a tax cut’s costs created by a “static” model would miss that growth, so economists have attempted to develop “dynamic” models that account for behavioral changes that come after tax cuts.

The problem is, the models they’ve built don’t really reflect how people behave, and tend to significantly overstate the effects of the tax cuts. Sometimes that’s because changes in tax law that lead to lower rates while closing loopholes may not lower effective tax rates for everyone, and the hoped-for incentives don’t materialize. But it’s also because the assumptions used by key analysts studying the tax proposals—notably those from the Congressional Budget Office—don’t actually reflect data gathered by economists in the field.

The assumptions in question concern how workers react to changes in their wages. While economists who study actual workers with changing wages find that it has little effect on their behavior, dynamic scoring models tend to assume a large one. A report last January from the Congressional Research Service concluded that “these models still rest on unproven, and probably unreasonable assumptions about the elasticity of substitution between consumption amounts that are ten or twenty years apart.”

For a more concrete example, consider the 2003 tax cuts enacted by president George W. Bush. These cuts dramatically lowered taxes on income and investment gains for the wealthiest Americans. “Lower taxes and greater investment will help this economy expand,” Bush said in his State of the Union speech that year. “More jobs mean more taxpayers and higher revenues to our government.”

At the time, the CBO warned (pdf) that they also would lead to years of deficits. But the Heritage foundation, a conservative think tank, used a dynamic model to predict that budget surpluses would quickly return despite the tax cuts. Here’s how that went: