Economic Confusion at CBO?

This article was published in the Washington Times, April 6, 2003.

The Congressional Budget Office’s “Analysis of the President’s Budgetary Proposals” is the agency’s amateur audition for something it calls “dynamic scoring.”

Until now, that phrase mainly meant taking into account how people are likely to respond to different tax incentives. But genuine dynamic scoring would be an admission the CBO has been doing its job badly, so CBO bureaucrats had a strong incentive to botch this unwanted job as meticulously as possible. Asking the CBO to go through these unfamiliar motions was like asking employees of the Social Security Administration to report on the benefits of privatizing their Ponzi scheme.

Under the circumstances, the wording of the CBO report generally reflects surprisingly good economics. The numbers are a different matter. Alleged estimates of supply-side effects are somehow squeezed out of two private models, which, a footnote reveals, “are designed primarily to capture short-run business-cycle developments.” Such models are famously useless for forecasting the next quarter, much less then next 10 years. And tinkering with an antique Keynesian computer program could no more convert a demand-side model into a supply-side model than it could turn a rotting pumpkin into a gilded carriage.

The writers of the report were thus forced to fabricate seemingly dynamic excuses for budget estimates spewed from rehashed Keynesian models. This tension can be painful to watch. The report is properly emphatic, for example, that fiscal devices to “stimulate demand” are “temporary” and unreliable at best: “Deliberate attempts to employ budgetary policies to aid cyclical recoveries have had little systematic success.” Yet they are compelled to observe that estimates from demand-side models claim, by contrast, that “the demand-side effects would in some cases be larger than the supply-side effects over the next five years.” The models the CBO rented are demand-side to the core, so they attach numbers to what the smart side of the CBO says is flatly impossible — predicting systematic success from demand-side policies.

Another strained effort to rationalize these estimates of “aggregate demand” actually leaves the CBO arguing that a stock market rally would be bad for investment. “Because increased share values lead to more consumption,” says the CBO, “the president’s proposal [to ease the dividend tax] would help increase aggregate demand in the short run. However, the more it would help demand by raising consumption, the more it would hurt supply in the long run by lowering saving and investment.”

Years ago, I dubbed this “zero-sum reasoning” — the static notion that investment and living standards cannot possibly grow at the same time, even though that is exactly what happens whenever economies grow.

For the CBO to claim a rising stock market would be bad for business investment and personal wealth (savings) reveals an attack of the highly contagious bureaucratic self-defense disease. Similar defensive illness is apparent in the whining over “no clear consensus” about this or “unclear” agreement about that — as an excuse for ignoring, among other things, well-documented supply-side effects on educational investment and entrepreneurship.

In another pathetic effort to avoid troublesome research, the CBO suggests that evidence that people respond to tax incentives may actually just be a response to budget deficits.

According to the CBO, the president’s proposals “would increase the federal budget deficit, which could lead people to expect that some time in the future, taxes would have to be increased or transfer payments [reduced]…. If people expect to face higher tax rates on labor in the future, the may try to work more before the tax rates go up.”

This trendy fable is abused by economists Joel Slemrod and Alan Auerbach to imply that supply-side incentives are ephemeral. Yet the conclusion (working more) contradicts the premise (big deficits). If people work harder today because they fear deficits mean higher tax rates tomorrow, they would pay more taxes today and the deficits would vanish.

An editorial in The Washington Post relished the news that “the CBO’s first foray into dynamic analysis showed ‘small’ effects,” implying that these small effects can be attributed to lower tax rates on work and dividends. The New York Times was far more honest, explaining that “tax cuts that might increase growth would be almost entirely offset by spending increases that would reduce it.” Increased government spending, says the CBO, must “reduce investment in productive capital by reducing the resources available.” It certainly does not follow we would be better off were Congress to enact the harmful spending but not the helpful tax cuts.

In fact, the CBO says supply-side incentives are the only effective means to increase economic growth: “Lower marginal federal tax rates on labor and capital income… would tend to increase labor supply, investment in productive capital (such as factories and machines) and the economy’s output…. Over the long term, the effects of budgetary policies depend on the degree to which they alter incentives to acquire skills, work, save, innovate and undertake investments.”

The CBO worries that only “a subset of the president’s proposals are [sic] intended to increase those incentives…. The remainder of the revenue proposals and those that would increase [federal] spending … would likely reduce growth in the long run by increasing government and private consumption at the expense of saving and investment.”

It is true that only about 60 percent of the 2003 Bush tax plan and 45 percent of the 2001 tax law would have any supply-side impact. But anyone who worries about too much private consumption (higher living standards) should consider how little after-tax income consumers will have left if Congress does little or nothing about taxes.

Under the CBO baseline, the 2001 tax law would expire in 2010, pushing the four highest tax rates up by 12 to 13 percent, pushing the lowest tax rate up by 50 percent, and reviving the 55 percent estate tax. The CBO therefore expects taxes to rise from 17.6 percent of GDP this year to 20.6 percent by 2013. Senators and journalists pretending to oppose tax cuts are really proposing huge tax increases. Under the president’s tax plan, by contrast, taxes rise to “only” 18.8 percent of GDP (partly because many more taxpayers become snared by the demonic minimum tax).

The combined Bush “tax cuts” of 2001 and 2003 would not even suffice to hold the line on taxes, but they would be far more tolerable than the soaring baseline against which these modest cuts are now being scored.

If Congress does nothing, the individual income tax is projected to rise by 35 percent over the next 10 years — from 8.1 percent to 10.9 percent of GDP. For every $1,000 you now pay in taxes, the baseline expects you to eventually cough up $1,350. It is doubtful voters would let that happen, and even more doubtful that the economy would look very dynamic if they did.

Alan Reynolds is a senior fellow with the Cato Institute and is a nationally syndicated columnist.