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1 1 (February 27, 2025)

handle is hein.crs/govespj0001 and id is 1 raw text is: Congressionol Research Service nforming the IegisI9tive debate since 1914 February 27, 2025 Selected Issues in Tax Reform: Dynamic Scoring Dynamic scoring includes, in projections of revenue effects, indirect changes in tax collections due to the overall growth effects on the economy. If the economy becomes larger due to the tax cut, tax revenues are larger because of the larger base, offsetting part of the cost of the tax cut. ref Summary of Current Pract ces The estimated revenue effects (i.e., the score) of tax revisions are prepared by the Joint Committee on Taxation (JCT) and provided to the Congressional Budget Office (CBO); CBO provides the cost estimates for legislation. These estimates assume no changes in the overall size of the economy, although they do allow for other behavioral effects (such as a change in capital gains realizations). When legislation is considered, by tradition and norm, these JCT and CBO estimates are the basis for determining compliance with the budget rules. Beginning in 2003, House rules provided for advisory estimates of the dynamic score, and the JCT usually provided a range of estimates based on different models and assumptions. In most analysis of major legislative changes, estimates of macroeconomic effects of tax cuts or other changes varied considerably, although none were large enough to offset a revenue loss estimated by conventional methods. Dynamic scoring requirements have varied over time, sometimes in House rules and sometimes in budget resolutions. These changes are detailed in CRS Report R46233, Dynamic Scoring in the Congressional Budget Process, by Megan S. Lynch and Jane G. Gravelle. In any case, no law requires the use of the JCT-CBO score; budget scores are decided by the budget committees, and by tradition, by the committee chairs. Uncertainties n Dynamic Scoring The many macroeconomic analyses by the JCT over the years, as well as macroeconomic analyses of the President's budget by the CBO, have shown a broad range of projected effects and illustrated the uncertainties about these dynamic scores. For a more complete discussion, see CRS Report R43381, Dynamic Scoringfor Tax Legislation: A Review of Models, by Jane G. Gravelle. The projected effects of a tax measure on economic growth depend on the type of effect considered and the assumptions surrounding the magnitude of the effect. Three types of effects can be considered. Demand-Side Effects Short-run demand-side (often termed Keynesian) effects result from employing additional resources in an underemployed economy. They tend to increase output for tax cuts and decrease it for tax increases, although the magnitude of the response also depends on the type of tax change and whether it is more likely to affect spending. The effect also depends on how close the economy is to full employment, how open (with trade and capital flows) the economy is (fiscal stimulus is less powerful in an open economy), the fundamental behavioral effects, and the extent to which the Federal Reserve may take actions that offset the effect. Because the economy is currently at full employment, a fiscal stimulus is unlikely to produce significant output effects but could increase inflationary pressures. Demand-side effects are transitory and should fade over time. During the first congressional hearings in 1995 on dynamic scoring (Joint Hearing Before the House of Representatives Committee on the Budget and the Senate Committee on the Budget, 104th Congress, Review of Congressional Budget Cost Estimating, January 10, 1995), many economists counseled against including these transitory effects in dynamic scoring. Supply-Side Effects Supply-side effects capture the increases or decreases in labor and capital that increase or decrease output. Average reductions in taxes reduce the supply of labor and capital, but marginal reductions (decreases on the last increment of supply) increase the supply as the consumption that people can achieve by working becomes cheaper relative to leisure. Similarly, the effect of a tax increase is theoretically ambiguous. Labor-supply effects can happen relatively quickly, but capital income effects tend to accumulate more slowly and then settle down into a steady state long-run effect. Both the speed and the size of supply-side effects depend on behavioral responses. Empirical evidence suggests labor supply and savings responses are relatively small, and models that apply the elasticities from the literature to a growth model tend to obtain small results. Some models (life-cycle and infinite-horizon) allow individuals to choose consumption and leisure over a lifetime or an infinite period of time, taking into account future wages and rates of return. In these models, embedded elasticities are sometimes larger than those suggested by the literature (see CRS Report R43381, Dynamic Scoringfor Tax Legislation: A Review ofModels, by Jane G. Gravelle). Supply-side effects also depend on whether the modeling takes place in a closed or open economy. If the economy is open, the effect depends on how substitutable capital is internationally.

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