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Do tax cuts partly pay for themselves?

Now that Republicans have taken control of the House and Senate, they are pushing to change how the Congressional Budget Office (CBO) and the Joint Tax Committee (JTC) evaluate tax legislation.

The effort is being made on two fronts. The first is an attempt by many Republicans to replace the director of the CBO, Doug Elmendorf, with someone more sympathetic to a new approach to evaluating the budgetary impact of proposed legislation. The second is a push from Rep. Paul Ryan, R-Wisconsin, who will take over as chair of the to the Ways and Mean Committee in January, to implement a new rule that would require the CBO and JCT to implement the alternative approach.

At issue is what is known as "dynamic scoring." Presently, when tax bills or other legislation are evaluated, the impact does not include changes in the macroeconomy, e.g. the effect of the legislation on the growth rate of GDP over time. Republicans are hoping to change this because they believe taking account of how tax cuts affect economic growth would reduce the budgetary impact of their proposals and make them easier to pass.

This is the basis for the often-heard claim that tax cuts can actually pay for themselves, though there is little evidence that this "Laffer curve" effect has ever happened in practice. The evidence suggests that tax cuts increase the deficit rather than reducing it, as Laffer claimed could happen. The more reasonable claim is that once the impact of a tax cut is taken into account, the impact on the deficit will be smaller because higher economic growth rates lead to increased tax revenue.

How much of an impact would this change have? If the best evidence on this question is taken into account, not as much as Republicans hope. When previous tax cuts are examined econometrically, the impact on economic growth is hard to find. There does appear to be an effect according to some of the research (but not all), but the effect is relatively small -- certainly not big enough to make a significant change in the budgetary impact.

Such a change could also benefit legislative proposals that Democrats favor. For example, to the extent that programs such as Head Start, Obamacare, food stamps, etc. lead to more productive, better, healthier, more educated workers, they will enhance economic growth and increase future tax revenues that partly offset the amount of money spent on these programs. Spending on infrastructure could also increase economic growth, perhaps substantially, and that would make a big dent in the budgetary impact of these programs.

If dynamic scoring is likely to benefit Democrats as much as Republicans, then why are Democrats so opposed to this change?

Some Democrats worry that CBO director Elmendorf will be replaced by someone willing to cherry pick the evidence on tax cuts to benefit Republican proposals and minimize benefits of the change to Democratic legislation. That would politicize an institution that has done its best to evaluate the budgetary impact of legislative proposals based upon solid evidence rather than politics and ideology and do great harm to an important part of the legislative process.

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