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  • New House Rule Puts Dynamic Scoring of Tax Legislation in the Spotlight
     
    January 2015
     
    On January 5, 2015, the House of Representatives adopted H. Res. 5, which provides certain basic procedural rules for the 114th Congress.  Included in the resolution is a provision requiring “the Congressional Budget Office and Joint Committee on Taxation, to the extent practicable, to incorporate the macroeconomic effects of ‘major legislation’ into the official cost estimates used for enforcing the budget resolution and other rules of the House.” Incorporating macroeconomic effects into official cost estimates of legislation is popularly known as “dynamic scoring.” This approach to estimating tax revenue has been discussed for many years but has never been officially adopted. Should significant tax legislation be proposed during the 114th Congress, dynamic scoring of that legislation could have a significant impact on how such legislation is perceived by members of Congress and the public.
     
    What is Dynamic Scoring?
     
    As part of the budget process, the Congress requires projections of the government’s revenue and expenditures. A forecast based on current government policy is referred to as a “baseline.” A forecast of the changes in expenditures or revenues resulting from proposed legislation is referred to as “scoring.” Baseline forecasts of government revenue are provided by the Congressional Budget Office. Scoring of tax legislation is done by staff of the Joint Committee on Taxation.[1]
     
    The scoring of tax legislation by the Joint Committee[2] necessarily takes into account the baseline of the Congressional Budget Office. In scoring tax legislation, the Joint Committee also takes into account the effects that proposed tax legislation may have on taxpayers’ behavior, e.g., an increase in the tax rate of capital gains may result in a reduction in the amount of gains realized. The Joint Committee has not, however, considered the macroeconomic effects (e.g., effects on interest rates, GDP, etc.) of proposed tax legislation as those effects may impact future tax revenues (e.g. by stimulating or retarding economic activity) [3] Thus, in the past, GDP and other macroeconomic variables were held constant when scoring proposed tax legislation.
     
    The macroeconomic consequences of tax legislation have not been ignored, however. Since 2003, House Rule 13 has required the Joint Committee to provide a macroeconomic impact analysis of tax legislation reported by the House Ways and Means Committee, or a statement explaining why such an analysis is not calculable. [4] Thus, dynamic analyses have been performed, but they were not included as part of the Joint Committee’s official revenue estimate. As a result of H Res. 5, a dynamic analysis now will be done in reaching Congress’s official revenue estimate.
     
    The Joint Committee’s Approach to Dynamic Scoring
     
    The staff of the Joint Committee currently uses three macroeconomic models, which it updates frequently based on academic research and the types of legislative proposals requiring analysis.[5] According to the Joint Committee’s staff, after the proper macroeconomic models are developed, there is the additional challenge of distilling each legislative proposal into inputs for the Joint Committee’s economic models.[6]  This involves various questions including (i) whether the tax proposal has an effect on the individual tax model or the business tax model, (ii) what is the proposal’s type of effect (average tax rate, marginal tax rate or cost of capital) and (iii) is the effect related to depreciation. As part of the estimation process, the Joint Committee checks whether the percent change in revenue owing to the projected macroeconomic response is roughly consistent with the projected percent change in GDP.[7]
     
    The staff of the Joint Committee recently stated that “we think we have been producing reasonable [dynamic analyses] for over a decade.”  However, the staff also has characterized dynamic scoring as a “new and significant challenge.” “We are currently assessing the best way to provide members of Congress information on likely macroeconomic feedback effects that best represents the current state of macroeconomic research.”[8]
     
    Pros and Cons of Dynamic Scoring
     
    There are various arguments in favor of dynamic scoring.  The most significant, perhaps, is that it makes use of more information in estimating the effect of a proposed tax provision than does the current method. Also, the current method, which ignores feedback effects on macroeconomic variables, is at odds with reality, at least with respect to major tax changes. For example, tax cuts may stimulate economic growth over some period of time that, to some extent, offsets the lost revenue associated with the cut.[9] 
     
    A move to dynamic scoring necessarily draws attention to the limitations of economic models of the economy and points to issues to be addressed: While there is evidence about the microeconomic effects of tax changes, the macroeconomic effects are less well known and so more difficult to model.[10] Dynamic scoring also requires assumptions about monetary and fiscal reaction to tax changes.  Budgetary effects also need to be accounted for.  Dynamic scoring utilizes the baseline and therefore requires the baseline to be updated more frequently than it otherwise would be.  Finally, there is the issue of which macroeconomic model to use and the assumptions to be included in the chosen model.[11] 
     
    Some have suggested that the choice of economic model and assumptions could be influenced by political factors. They reason that because the output of the models are sensitive to the assumptions employed, and such assumptions are subjective, the staff of the Joint Committee could be inclined to make assumptions leading to projections that satisfied expectations of the majority party.[12] Others have posited that some economic models estimate stimulating effects that are transitory and only matter when there is unemployment in the economy.[13]
     
    Observations
     
    The Republican-controlled Congress likely was motivated, at least in part, to adopt dynamic scoring because this Congress may consider legislation that includes a tax-rate cut coupled with a broadening of the tax base. Such legislation might be viewed more favorably if the Joint Committee’s scoring of such legislation showed tax cuts as stimulating economic growth and offsetting, at least somewhat, the revenue loss associated with the tax cut.[14]
     
    Altouhg dynamic scoring likely is an improvement over the current methods of revenue estimation, it is far from perfect.  Dynamic scoring may lead to undue confidence in the revenue estimate produced by an economic model.  This is particularly true if Congress is given revenue estimates without any information about the sensitivity of the estimates to assumptions and initial conditions. Moreover, the output of econometric models typically include a range of values and that range may be quite broad. Thus, a single point estimate of the revenue effect of a tax cut may be misleading, To the extent, the political process draws attention to these issues, the results of dynmaic scoring employed may be used more judiciously.
     
     
    [1] See Auerbach, "Dynamic Scoring: An Introduction to the Issues," 95 Am. Econ. Rev. 421 (May 2005) herinafter Auerbach.
    [2] According to the Joint Committee's website, “The Joint Committee on Taxation is a nonpartisan committee of the United States Congress, originally established under the Revenue Act of 1926. The Joint Committee operates with an experienced professional staff of Ph.D. economists, attorneys, and accountants, who assist Members of the majority and minority parties in both houses of Congress on tax legislation.”
    [3] Auerbach.
    [4] Gravelle, Dynamic Scoring for Tax Legislation: a Review of Models, Congressional Research Service (January 24, 2014) hereinafter Gravelle.
    [5] Joint Committee on Taxation, "Dynamic Scoring: Now What?" JCX-3-15 (January 26, 2015).
    [6] Id.
    [7] Id.
    [8] Id.
    [9] There is a diversity of views as to the magnitude of the effect, but economists generally believe that this effect is not so great as to offset the revenue loss of a tax cut. See, e.g., Gravelle.
    [10] Auerbach.
    [11] See the Congressional testimony of John L. Buckley in April 2014 available at: http://www.budget.senate.gov/democratic/public/?a=Files.Serve&File_id=2164af13-dce5-4cfd-9b51-229d2538034a/.
    [12] Buckley, Dynamic Scoring, Will S&P Have Company?, Tax Notes (March 2, 2012).
    [13] Gravelle.
    [14] For example, former Chairman Camp's tax-reform proposal.
    KEYWORD: Federal Budget